James Tyler explains how to fix banking. This article originally appeared on hedgehedge.com.
Open your wallet. Take out that £10 note. It’s yours. Your property, to spend as you wish. Put it in a bank, and you enter Alice’s Wonderland.
Most people in this country believe that when your money is placed in a bank account, it remains their property. Nothing could be further from the truth. Once you hand it over, it becomes the bank’s property: what you get in return is a promise that they will repay you if you ask for it. Why does this matter? Because the bank will then lend it to somebody else – and not on the same terms.
Think about what this means for a while.
If the money has been lent to somebody else… surely it’s not there. Yet you have been promised instant access. Surely the person who has borrowed the money has the right to it? The fact is both you and the borrower can use the money – at the same time. How can this possibly work?
Well, the banks say “not everyone will want to take their money out at the same time. We carefully plan and monitor withdrawals, and we don’t lend the whole lot out – we keep some in reserve to cover withdrawals”. True, for every £100 you put in, they keep a hefty reserve.
A truly massive £3.
Worried yet? It’s only the start.
Ok, so you deposit £100 at Bank ‘A’, and they keep £3 and lend out £97. Happy days, you get interest, that must be the end of it right? Wrong.
A business man borrows that £97, and uses it to buy some widgets from WidgeCo. WidgeCo receives the £97 and deposits it at Bank ‘B’. Is it dawning on you yet?
Bank ‘B’ now takes the £97 and promises instant access to WidgeCo. However, Bank ‘B’ keeps £2.91, and lends out the remaining £94.09 to Mr Smith who wants to borrow to buy a house….
So how are we left with your £100 that the bank is keeping safe for you?
You now have a claim to that £100. The business man has claim to £97 (which he has spent), WidgeCo has a claim to £97. Mr Smith also has a claim to £94.09.
The person who sells the house get’s the 94.09 and deposits it. And so on, and on, and on, and on, in a recursive loop until there is no ‘money’ left to lend.
This is fractional reserve banking in process. On average in the UK, there are 34 claims to every £1 of ‘real’ money in circulation. Except it’s not real money… it is a flexible concept called ‘credit’. A close-to-money substitute that we have been conditioned to treat as if it were real money. I call it a Ponzi scheme perpetrated by Banksters. It would be fraud, except is has a peculiar legal protection.
It is a legalised Ponzi pyramid.
Why is this a bad thing? Well, aside from the moral concept of your property being loaned out again and again and again, there is the boom bust cycle that all this flexi-credit creates.
In the good times your £100 is handed many times, credit increases, and the supply of money expands. A boom ensues. Any proposition is listened to, anyone can get a 110% mortgage for a buy-to-let, the poor get pressured into borrowing too much to buy council homes, any speculator can find finance for any mad capped scheme, and silly websites can borrow millions to flush down the plug hole.
In the bad times, banks get worried, call loans back in, credit evaporates, money supply contracts, Joe Bloggs loses his home, businesses fail, ordinary folk lose their jobs, politicians start blaming banks for not lending money, and recession or depression ensues.
Welcome to the credit card society. Binge and bust banking.
There is a better way.
In 1936 the great economist Irving Fisher proposed a solution, but was promptly drowned out by J.M Keynes’ mad cap ideas that suddenly became all the fashion. The lunacy of Keynes’ ideas is worth examination, (employ one man to dig a hole, and another to fill it, you will generate economic wealth… not sure how, but that’s Keynesianism for you), but the full expose is best served in one helping at another time.
What Fisher proposed was that we should treat notes and coin and accounts with instant access as cash and force the banks into keeping a full 100% reserve (not the miniscule 3% we are used to today). This means that banks would be forced to keep your cash safe for you. Loans should be financed by an explicit undertaking of the depositor to tie his cash up for a pre-determined amount of time.
In short hand, you make fractional reserve banking a fraudulent activity, punishable under law.
Think of a safety deposit box. You go to a vault and store some jewellery. Do you expect the company providing the vault to then open the box, take your wife’s nice gold necklace, and lend it out to the bank’s best customer’s wife? Not on your nelly.
We can sort this mess out right now.
Take all of the current and instant access deposit accounts, and call it what it should be called: cash. Tell the Banksters it is your property. Tell them we’ll chop their wotsits off if they dare lend it out – it’s your property. This is a 100% reserve.
However, if we convert all of the positive balances into cash, owned by you, then the Banksters no longer owe you anything: they no longer have the liabilities. This isn’t fair as they now have all of those lovely loans that they’ve made, for free.
Not so fast.
All of those loans should be hived off into a separate mutual fund: the interest income (and loan repayments) should be diverted into paying off the national debt.
Banks become very boring and safe institutions.
Think what has happened.
- We have formalized credit, and turned it to money – this is not inflationary because no new ‘money’ has been created: credit is now cash
- The Banksters have lost their lucrative racket – no more profits from Ponzi.
- Banksters are now reformed into Bankers. They have to look after your money, sell you simple banking services like wire transfers, chequing accounts and so on
- An end to boom and bust… or at least the greater portion of the economic cycle that is exacerbated by gyrations in credit.
- No more bank crises. With 100% reserves no bank can go bust because of a liquidity concern. Sure banks can lend badly, and lose – but they can’t lend your liquid cash.
- We stop pouring gasoline on normal business cycles, turning them into booms and associated busts.
- Morally, owning your money is right. Your property remains your property unless you explicitly agree to lend it out at interest, in which case you transfer ownership for a pre-set time.
- We kill inflation, and promote stable economic growth and much reduce labour market tensions. Militant unionists cannot agitate for pay rises to ‘maintain a standard of living’.
- We impose discipline on the state. Governments can no longer spend what isn’t theirs, and pay for it by expanding the money supply.
- We can get rid of central banks, and the money planners. Why would we need bureaucrats? No more liquidity worries means we do not need a lender of last resort.
- 100% reserves are the most compatible system to work alongside democracy. No more monopoly profits for Banksters (at our expense). Government action will require open conversation and explicit decisions on the part of our representatives.
- A worldwide system of full property rights to money and 100% reserves would prompt peaceful and harmonious cooperation amongst nations. Look at any war in the last two hundred years, and you will find that rampant money creation has played its part and paid for the escalation of most conflicts. Funny money finances war.
- Irving Fisher, 100% Money, 1935
- A day of reckoning: how to end the banking crisis now
- How To Destroy the British Banking System
- Economic Interventionism, Banks and the Crisis
- Huerta de Soto, Money, Bank Credit and Economic Cycles
- What is wrong with banking, part 1: the legal nature of banking contracts
- For more detail from James: How to avoid future encounters with financial meltdown
So what would the Banks now lend? Term deposits only? How much of a contraction of credit does this represent? Would a lot of firms fold without financing? It would be nice to know before signing off on this.
What is it the banks lend now? Are you happy that the £100 in your instant access deposit account is being used to lend to £1000 Dubai World? If Dubai World reneges, are you happy to lose your £100 that you thought was being held safely for you? Who pays for the other £900? Or should an innocent tax payer pick up the whole tab?
Investment, in the long run, only comes from deferred consumption, yet in the short run fractional reserve banking muddies this by giving the illusion that, during a boom, there are more savings than actually exist : the builder starts work not realising that he doesn’t have enough bricks to finish the house. In the inevitable bust, gravity re-asserts itself and credit contracts. Unless, that is, the authorities step in and print more money (thus debasing the purchasing power of your £100).
100% reserves is a means to even out the alternative manic/depressive phases of credit induced economic cycles. In the long run, 100% banking does not change the net total money available for investment, just makes sure it is available at ALL times for the owner of that money to use as they see fit.
How would lending take place in a 100% reserve world? Pretty much as it does now for corporations and the banks themselves: fixed term loans, certificates of deposit and bond issues. Honest banks would act as intermediaries between those willing to defer consumption and those with the need to borrow. If people chose not to invest, they would have to pay a storage fee – this would be enough to incentivize most into seeking out lending opportunities in line with their risk appetite.
What about overdrafts, credit cards and such? Money market mutual funds could attract investors by selling units (with a floating price), and then lend money out in this manner. Liabilities without a definite maturity could then be matched by investments of the same nature (or any nature the fund advertised). An investor could exit by selling his units. If the fund did well, the price of units would rise, if the fund made poor lending decisions, the value of units would fall, and the investor would take a haircut.
The point here is that this would be a transparent process. This effectively happens now with your instant access deposit money, except that if the ‘fund’ (i.e. the bank) does well, they make huge profits, if they do badly then the tax payer bails them out.
Oh, and don’t forget, this plan formalises all credit already in existence. So, there is absolutely ZERO change in outstanding loans: no contraction in credit. Neither deflationary nor inflationary in terms of the money supply.
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