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>> No. 5817 Anonymous
10th October 2015
Saturday 7:00 pm
5817 Banning Banks
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.
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>> No. 5822 Anonymous
11th October 2015
Sunday 10:10 am
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You know, i've never actually thought about this before. It seems to be a pretty fucking big deal that a bank can essentially just wave a wand and give someone three grand out of nowhere, just due to the nature of being the ones who keep track of how much everyone has. The money exists only as numbers in various comluter systems by this point.

It doesn't make sense. If my mate Dave wants to lend a tenner, I have to have a tenner to give him.. Why are banks allowed to cheat?
>> No. 5823 Anonymous
11th October 2015
Sunday 11:02 am
5823 spacer
Be careful discussing this. Fractional reserve banking is not fundamentally problematic.
>> No. 5824 Anonymous
11th October 2015
Sunday 12:05 pm
5824 spacer
Money existing as numbers in a computer is fine. Money existing on paper is fine. They're both arbitrary, but both serve a purpose, and if they actually aid the economy, they're a good thing.

The one fundamental problem with fractional reserve banking is that it's impossible. At least it is in the way that it's popularly conceived.


It relies on the money multiplier which is just a straight up myth at this point:


>Charles Goodhart (2007), the UK’s preeminent monetary economist: “... as long as the Central Bank sets interest rates, as is the
generality, the money stock is a dependent, endogenous variable. This is exactly what the heterodox, Post-Keynesians ... have been correctly claiming for decades, and I have been in their party on this.”

>Borio and Disyatat (2009), in a Bank for International Settlements working paper: “In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs and by the demand for those loans.”

>Disyatat (2010), again from the BIS: “This paper contends that the emphasis on policy-induced changes in deposits is misplaced. If anything, the process actually works in reverse, with loans driving deposits. In particular, it is argued that the concept of the money multiplier is flawed and uninformative in terms of analyzing the dynamics of bank lending.”

>Carpenter and Demiralp (2010), in a Federal Reserve Board working paper: “While the institutional facts alone provide compelling support for our view, we also demonstrate empirically that the relationships implied by the money multiplier do not exist in the data ... Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected...”

The conclusion of the real world effects of how banks actually operate is pretty fundamentally problematic:

>Economic models that integrate banking with macroeconomics are clearly of the greatest practical relevance at the present time. The currently dominant intermediation of loanable funds (ILF) model views banks as barter institutions that intermediate deposits of pre-existing real loanable funds between depositors and borrowers. The problem with this view is that, in the real world, there are no pre-existing loanable funds, and ILF-type institutions do not exist. Instead, banks create new funds in the act of lending, through matching loan and deposit entries, both in the name of the same customer, on their balance sheets. The financing through money creation (FMC) model reflects this, and therefore views banks as fundamentally monetary institutions.

>The FMC model also recognises that, in the real world, there is no deposit multiplier mechanism that imposes quantitative constraints on banks’ ability to create money in this fashion. The main constraint is banks’ expectations concerning their profitability and solvency.

>In this paper, we have developed and studied simple, illustrative models that reflect the FMC function of banks, and compared them to ILF models. Following identical shocks, FMC models predict changes in bank lending that are far larger, happen much faster, and have much larger effects on the real economy than otherwise identical ILF models, while the adjustment process depends much less on changes in lending spreads. As a result, FMC models are more consistent with several aspects of the data, including large jumps in lending and money, procyclical bank leverage, and quantity rationing of credit during downturns. Our results suggest that a quantitative investigation of the effects of macroprudential policies using FMC models is likely to yield results that differ significantly from the existing literature. We are confident that this will generate a very useful research agenda.
>> No. 5833 Anonymous
12th October 2015
Monday 11:08 pm
5833 spacer
There's a proposal currently being considered by the Icelandic government to do just this, by the way: http://www.telegraph.co.uk/finance/economics/11507810/Iceland-looks-at-ending-boom-and-bust-with-radical-money-plan.html

Their proposal in full is available here, well worth a read: http://www.forsaetisraduneyti.is/media/Skyrslur/monetary-reform.pdf

It's essentially the same as the solution offered by Positive Money (http://positivemoney.org/)

>> No. 5834 Anonymous
12th October 2015
Monday 11:29 pm
5834 spacer
I want to respond to this to keep the thread going but I don't feel informed enough to contribute. I consider myself to have a pretty good outlook on ececonomics, despite only formally going insofar as A level, and the idea of banning banks is against my general political outlook, but I want to read and learn more so don't feel disheartened by a lack of responses please.
>> No. 5835 Anonymous
13th October 2015
Tuesday 12:20 am
5835 spacer
Yeah, the main problem with the whole thing is that it's ridiculously counter-intuitive, both to the public, and to people with backgrounds in economics.*

To be clear, "banning banks" is sort of hyperbole. It's the removal of a certain power from the banks which would fundamentally change their role. It's not nationalising them, that wouldn't even address the issue so long as they were still able to create money through credit.

This isn't really a political issue,** or rather it shouldn't be. It's an issue of monetary policy, and whether we want the money supply to be controlled via the mechanism of financial money creation with a view to making profits (a system which is demonstrably unstable: "Following identical shocks, FMC models predict changes in bank lending that are far larger, happen much faster, and have much larger effects on the real economy") or by a central bank with a view towards stabilising the economy. I don't think the typical "state vs private provision" argument is applicable here.

There are political concerns, like inequality, which are related to the issue (which are often highlighted by the Positive Money folks I posted about above), but if what Wicksell, Schumpter and Fisher believed a long time ago is true (and the consensus is looking to point more and more in that direction) there is a fundamental problem of economic instability in our system, and I think people of all political stripes can agree that that is something that needs to be addressed, be it through total reform or an attempt to impose proper constraints within the currently existing system.

* To quote again from the BoE working paper: "In undergraduate textbooks one also finds the older deposit multiplier (DM) model of banking, but this has not featured at all in the recent academic literature. We will nevertheless discuss it later in this paper, because of its enduring influence on popular understandings of banking". Which is somewhat irresponsible in my view, considering how influential politicians and advisers can become with just an undergrad economics degree. I remember going from GCSE chemistry to A level and being told "most of what we taught you about atomic structure was at best a simplification and at worst lies". The least that universities could do is explain that elements of what they're teaching have been largely discredited. I suppose people might wonder what hell they're paying nine grand for then, but I digress...

** Or a party political issue. There was a debate on money creation in the commons last year (the first in almost two centuries. The last one happened around the time of the 1844 Bank Charter Act, which essentially banned banks from doing this exact thing, but didn't foresee how it could recur in the future: http://positivemoney.org/how-money-works/how-did-we-end-up-here/) and MPs from every party who appeared to "get" the issue were unanimous in recognising that it's a major problem:

>> No. 5836 Anonymous
13th October 2015
Tuesday 12:33 am
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There's also an argument that money creation by the private sector should be the only true form of money creation since money is just another commodity as a means of trade and isn't inherently special. The future may very well be different regions of currency not defined by international boundaries.
>> No. 5837 Anonymous
13th October 2015
Tuesday 2:05 am
5837 spacer
>this isn't some lone nutbar like Ron Paul shouting stuff into the wilderness
>> No. 5838 Anonymous
13th October 2015
Tuesday 4:30 am
5838 spacer
Money is not a commodity. It can be, but whether it would be wise to make it so is a wholly different argument.

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