|>>|| No. 5817
What do you lads make of the money creation debate?
Bit of a primer (full disclosure, I am in favour of a state monopoly): the idea that private banks create money has been discussed by mostly heterodox (like the post-keynesians) or "discredited" (like Irving Fisher) economists for over a century, but hasn't really been given much attention in the mainstream. The crash sort of sparked a bit of a revival of concerns about the idea, though. Sir Mervyn King expressed belief in it outright in 2012, saying "when banks extend loans to their customers, they create money by crediting their customers’ accounts".
The Bank of England released a quarterly bulletin last year endorsing the concept and also rebuking the "money multiplier" theory. It's an excellent, easily digestible explanation of the idea: http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx
There are a number of claimed drawbacks of this system. For one thing, it means that we need to take on large levels of debt to finance economic growth: for every £1 created by private banks, another £1 of private debt is introduced into the economy. In effect, if there’s £100 in your bank account, someone else must be £100 in debt. Given that privately created money makes up 97% of our money supply, you can see why this might be burdensome on the public. And if we were all to try to pay off our debts, we would likely cause a recession: just as banks create money when they lend, that money is destroyed when the loan is repaid. Mass repayment of debts would result in a contraction of the money supply. Debt is effectively "not a bug, it's a feature".
There is also the effect on house prices to consider: from 1998 to 2008, there were 3 new houses built for every 4 "new people", which makes the idea that the meteoric rise in prices was down to supply and demand look a bit shaky. The major contributing factor to the growth in prices was the fact that 31% of the money banks created during this time went into property. Prices would never have risen remotely as high as they did if banks hadn't funded the explosion.
The third major effect, and probably the worst, is instability. According to Lord Adair Turner, former Chairman of the FSA:
>The financial crisis of 2007/08 occurred because we failed to constrain the private financial system’s creation of private credit and money.
And Martin Wolf, chief economics commentator at the Financial Times:
>Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function
Essentially, having money creation driven by the profit motive leads to unstable outcomes. The solution, then, is quite obvious: a ban on private banking. Seriously. Well, private retail banking at least. Either through having a full reserve requirement, preventing money being lent that isn't backed by central bank guarantees, or through straight up state provision of transaction accounts. Either method would end private money creation, which could be delegated to a non-political entity, much like the MPC.
If this all sounds like mad shit, I 100% understand. Thing is, this isn't some lone nutbar like Ron Paul shouting stuff into the wilderness. The aforementioned chief economics commentator at the Financial Times, Martin Wolf, has backed the idea:
>A maximum response would be to give the state a monopoly on money creation. One of the most important such proposals was in the Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher. Its core was the requirement for 100 per cent reserves against deposits. Fisher argued that this would greatly reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff suggests this plan could work well.
Along with Lord Turner who stated, in an introduction to the proposal from Iceland's Chairman of the Committee for Economic Affairs and Trade to require fully backed reserves:
>They have still failed to address the fundamental issue – the ability of banks to create credit, money and purchasing power, and the instability which inevitably follows. As a result, the reforms agreed to date still leave the world dangerously vulnerable to future financial and economic instability. This report addresses those fundamental issues. It is rightly titled “Monetary Reform” because it goes beyond the technical details of bank regulation to question who should create money and how we ensure that new money is devoted to useful ends. It does a crucial job of public education, explaining how “fractional reserve” banks create money, and why excessive levels of private debt will inevitably result in crisis. And it explains why financial and economic instability cannot be effectively managed using only the interest rate policy tool on which central banks have traditionally relied.
That proposal is worth reading in its entirety by the way: http://www.forsaetisraduneyti.is/media/Skyrslur/monetary-reform.pdf
RBS Economists voiced approval of Iceland's proposed experiment:
>The key idea is a new Sovereign Monetary System, where only the central bank is responsible for money creation. The idea makes sense…Separating the creation of money and allocation of money powers could safeguard against excessive credit creation, and reduce incentives for commercial banks to create more credit to make private gains…Iceland’s proposal is worth exploring
Mervyn King hasn't exactly supported it, but appears to be dissatisfied with how things are currently, and is open to the idea:
>Of all the many ways of organising banking, the worst is the one we have today
>Eliminating fractional reserve banking explicitly recognises that the pretence that risk-free deposits can be supported by risky assets is alchemy. If there is a need for genuinely safe deposits the only way they can be provided, while ensuring costs and benefits are fully aligned, is to insist such deposits do not co-exist with risky assets
And a paper from a couple of IMF economists has backed Irving Fisher's original proposal:
>Our analytical and simulation results fully validate Fisher’s (1936) claims. The Chicago Plan could significantly reduce business cycle volatility caused by rapid changes in banks’ attitudes towards credit risk, it would eliminate bank runs, and it would lead to an instantaneous and large reduction in the levels of both government and private debt. It would accomplish the latter by making government-issued money, which represents equity in the commonwealth rather than debt, the central liquid asset of the economy, while banks concentrate on their strength, the extension of credit to investment projects that require monitoring and risk management expertise
And plenty of orthodox, influential, mainstream economists, from John Kay to John Cochrane to Nobel prize winner Milton Friedman have openly advocated the idea, with fellow Nobel lauretes like Paul Krugman and Robert Lucas considering the idea at least worthy of consideration.
Admittedly, even the fact that Very Serious People have called for an end to banking as we know it doesn't look like it will make it enter any genuine political progress any time soon, at least in this country. Maybe it'll take another crash or three. Still, it's a topic worth attention, I feel.