First – what is money? It is cash (coins and Bank of England notes), and balances held at the Bank of England. Who has a Bank of England account? It used to be that anyone could have a current account at the Bank of England, but nowadays it seems to be only the government and the banks. (I'd be grateful if anyone could provide more information on that). I have read that there was a move in just the last few years to force other account holders to move to the commercial banks. I even saw that HMRC has been moved to Nat West (part of RBS), so if RBS were to be or become insolvent then collected taxes could well be lost.
Where do Bank of England notes come from? Well, the Bank of England essentially has an ATM. A bank can ask the Bank of England for a withdrawal. The Bank of England reduces the balance in the bank's account, and sends round a big van with lots of new Bank of England notes, which the bank can load into an ATM, put in the cashiers' tills, and/or put in the petty cash box. The same process can work in reverse - the bank can send back some tatty old Bank of England notes (which are then shredded) and have their balance increased.
Where the original balances at the Bank of England come from is a subject for another post.
So, banks have accounts with the Bank of England. Let's look again at the example from the last post, where I have opened an account with Lloydclays Bank of Corporation (LBoC). I paid in £20 in Bank of England notes (money), and had my account credited with £20 of bank credit. LBoC put the money in the till — it belonged to them at that point. What happens if I write a cheque for £10 to Fred Madeupname, who also has an LBoC account? It's fairly simple:
Cheque processing
- I write a cheque showing the amount and my bank sort code and account number.
- I hand the cheque to Fred.
- Fred completes a paying-in slip showing the amount and his bank sort code and account number.
- Fred hands the paying-in slip and the cheque to a cashier at his local branch of LBoC, who checks that the amounts match.
- The branch send both slips of paper to a national cheque-processing centre.
- The cheque-processing centre reads all the details from the paying-in slip and the cheque, re-checks that the amounts match, and sorts the cheque into a pile to be sent to LBoC in case manual checking is required later. It also adds an entry to an electronic file to transmit to LBoC at the end of the day indicating the amount to be transferred, which account's balance is to be reduced, and which account's balance is to be increased.
- When LBoC receives the electronic file, it reduces the balance in my account by £10, and increases the balance in Fred's account by £10.
The end result is that my bank credit is reduced by £10, and Fred's bank credit is increased by £10. No money was involved.
Now let's instead assume that Fred has an account with a different bank, say Hong Kong of Scotland (HKoS). The process is almost the same, except that:
- The cheque sorting centre adds entries to two electronic files. LBoC are told to reduce my balance by £10, and HKoS are told to increase Fred's balance by £10.
- The Bank of England is notified that it must reduce LBoC's balance by £10 and that it must increase HKoS's balance by £10.
The Bank of England isn't interested in getting a notification of every single cheque written, so the amounts transferred are aggregated into a single transfer per pair of banks per day.
Note that in this case, there is a transfer of money. £10 was transferred from LBoC to HKoS — Bank of England deposits were modified.
Debit card processing and bank transfers
Let's say I use my LBoC debit card at Sainscose to pay for some shopping. What happens then? Well it's basically the same as the cheque processing, except that the whole thing is electronic, outsourced to a card-processing company, and quicker.
If Sainscose banks with LBoC, my account balance is decreased, and Sainscose's is increased. No money is involved, only bank credit.
If Sainscose banks with HKoS, my account is decreased, Sainscose's is increased, and a transfer of money takes place at a suitable point between the accounts of LBoC and HKoS at the Bank of England.
The same is true for bank transfers (BACS). Bank credit accounts are increased and decreased, and if the accounts are held at different banks, a money transfer is made between the respective banks' accounts at the Bank of England.
Bank credit vs money
We've looked at cheques, debit card payments, and bank transfers. As far as the bank account holder is concerned, there's very little difference between spending cash and spending bank credit. Cash and bank credit are pretty-much fungible — they can be used interchangeably when paying for goods and services. Cheques, debit card payments and bank transfers are very convenient in that they avoid the need to withdraw money, give it to the recipient, and for the recipient to deposit the money in their bank. But always remember that money and bank credit are separate things — bank credit relies on the bank being able to honour its promise to pay.
So far, we've only looked at bank credit being transferred or exchanged for cash. And cash can only come from deposits at the Bank of England, so unless there is something else we haven't yet considered, the amount of bank credit is limited to the amount of money in the system. In fact, there is something else, which will be the topic of a future post.
You are, I suggest, confusing both yourself and your readers. I think the confusion stems from two causes.
ReplyDeleteFirstly, bank credit is the same as money - contrary to your assertion. Bank credit (aka a loan) is added to the borrower's account and instantly becomes indistinguishable in any way from whatever cash he previously deposited in it, or may subsequently add to it. It's all, equally, money. All of it is available to spend.
Secondly, you seem to be being led astray by the fact that none of it is real money, in the sense that actually all of it is legally owned by the bank and shown on its balance-sheet as its asset. The account-holder owns only the bank's promise to pay that sum to him at any time he demands it. The promise is of course fraudulent and known to be fraudulent because exactly the same promissory note is held by all the other deposit-holders (amounting in aggregate to five or ten times the bank's capital reserve); but that's how fractional reserve banking operates:- as legalised fraud.
"If Sainscose banks with LBoC, my account balance is decreased, and Sainscose's is increased. No money is involved, only bank credit". Again, the failure to recognize the fact that both equally are the medium of exchange (= money). The seller's stock of this money is increased, and the buyer's decreased, by an equal and opposite value. This is unaffected by whether you hand over cash at the checkout, present a credit-card, or a debit-card. All, equally, are money (ie the medium of exchange). If you use a credit-card you in effect borrow the money to pay Sainscose from the credit-card company and repay it (with interest) later.
I'm certainly not confused about this. It's based on "Money as Debt", "Modern Money Mechanics" as published by the Federal Reserve Bank of Chicago, and Wikipedia, as well as other background reading such as Bloomberg News at http://www.bloomberg.com/
ReplyDeleteBank credit is similar to money, and can be spent like money, but there is certainly a difference between the two. That's why the terms "narrow money" and "broad money", as well as M0, MB, M1, M2, M3 etc. exist.
A major difference is that of who guarantees the value. Money obtains its value by being legal tender - it is declared to be good for paying debts. But the value of bank credit relies on the ability of the retail bank to provide money on demand in exchange for the bank credit. If it doesn't have enough, then the bank credit is worth( )less.
Strictly speaking, bank credit is not all available to spend. If everyone who has bank credit at a bank tries to spend it at the same time, it cannot be spent - you would have a liquidity crisis because there is not enough actual money to pay out. In this situation, if the loans it has made are still good, it can sell the loans on to another party in exchange for money to pay the creditors, or it can use the loans as collateral for borrowing money itself from other banks or other sources, again allowing it to pay money to the creditors.
I'll address the other point in another comment.
You are splitting hairs!
ReplyDeleteAnswer me this:- if at a supermarket checkout you pay for your goods with a debit-card, you are allowed to take your goods home; does that not tell you that you have made a purchase from that supermarket, and that you have made it with money? All you have done is use a piece of plastic instead of carting around a whole bundle of notes and coins.
You could of course have got the necessary cash from an ATM, using the same piece of plastic; or across the counter inside the bank.
It makes no difference!
"Secondly, you seem to be being led astray by the fact that none of it is real money, in the sense that actually all of it is legally owned by the bank and shown on its balance-sheet as its asset."
ReplyDeleteI hope that I've shown in the post "Creation of bank credit" at http://wheatonomics.blogspot.com/2010/08/creation-of-bank-credit.html that the bank credit is shown on the balance sheet as a *liability* of the bank, not an asset. It is an obligation on the bank to pay money as directed by the customer who has the bank credit in their account. That's a big responsibility taken on by the bank, and a big risk for it too.
"The account-holder owns only the bank's promise to pay that sum to him at any time he demands it."
I agree. This is why it is essential that the banks should remain solvent i.e. have more assets than liabilities (excluding shareholder equity i.e. the amount owed to the owners). Otherwise the bank couldn't keep its promises.
"The promise is of course fraudulent and known to be fraudulent because exactly the same promissory note is held by all the other deposit-holders"
Just a point of terminology: the bank credit is not the promissory note - the bank credit was created in exchange for the promissory note. A promissory note is a contract signed by a borrower to say that they will repay a certain amount of money (the sum borrowed plus interest) to the bank at a certain point (or points) in the future. Therefore there is one promissory note per borrower (or perhaps several if someone borrows from the same bank multiple times). They are not shared between borrowers.
Each promissory note causes a matching deposit of bank credit to be created.
"(amounting in aggregate to five or ten times the bank's capital reserve); but that's how fractional reserve banking operates:- as legalised fraud."
You're right that the amount lent is a multiple of the bank's capital (held as money or similar), but I don't see that that implies fraud. Are you suggesting that it is fraudulent because the bank wouldn't have the cash to pay all depositors if they asked to withdraw their balances all at once? While they couldn't quite manage it immediately, they could still provide the money if necessary - the bank could sell the promissory notes to another lender, could securitise them (sell the income stream from them on an ongoing basis), could borrow money from another bank using the promissory notes as collateral, or could issue more shares. As long as the bank is solvent i.e. has more assets than liabilities (excluding the amount owed to shareholders), the bank credit can always be converted to cash. And if the bank can meet its obligations in this way, I don't see how it can be considered to be fraud.
If it were fraud to make a promise to pay money in future when you don't have it now, then most borrowers would be committing an act of fraud, and most businesses would be too. The reason that it is not fraud is that they have the means to obtain money to pay when the payments become due - either by selling assets which they already own, or creating something of value and selling that.
"You are splitting hairs!"
ReplyDeleteI hope that I'm being informative - looking at some of the detail of our monetary system. If we're going to examine whether it is fraudulent or not, we need to understand it at a deeper level than is necessary for simply buying things. One thing I intend to do later is examine what happens when a bank becomes (balance-sheet) insolvent, perhaps because it lent money to people who were unable to repay. Understanding the monetary system in detail is essential to understanding what happens.
"Answer me this:- if at a supermarket checkout you pay for your goods with a debit-card, you are allowed to take your goods home; does that not tell you that you have made a purchase from that supermarket, and that you have made it with money? All you have done is use a piece of plastic instead of carting around a whole bundle of notes and coins."
For most everyday purposes, I agree that you can say that you have purchased something using "money". I have distinguished between money and bank credit because there are differences between the two. Withdrawing notes and coins with plastic, and paying with them, is similar. But one important difference is that you don't actually need the notes and coins to even exist to make the plastic payment. In fact, there are purchases which could not be made with cash - for example you couldn't buy BP with cash. It's valued at roughly £77B, and there's currently only £57B of notes and coins.
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ReplyDelete"If it were fraud to make a promise to pay money in future when you don't have it now, then most borrowers would be committing an act of fraud, and most businesses would be too. The reason that it is not fraud is that they have the means to obtain money to pay when the payments become due - either by selling assets which they already own, or creating something of value and selling that".
ReplyDeleteSo according to you there have never been any runs on banks and no banks have ever gone bust?
The reserve ratio now is around 34:1. How can you in all seriousness assert that "they have the means to pay" when as you put it "the money becomes due"? How can you fail to have understood that money placed on deposit is due ON DEMAND? That means, AT ANY TIME OF THE DEPOSITORS' OWN CHOOSING. Of course the banks do not have the means to meet that obligation (as bank runs demonstrate) and of course they know that full well when they pledge themselves to pay that money on demand. That is fraud, pure and simple.
The analogy you draw with the borrower's position is totally spurious, because he does not enter into a contract to repay the loan AT ANY TIME ON DEMAND, but at a specified date or on a specified schedule set out in the loan agreement. Furthermore, he has not pledged the same collateral 34 times over to 34 different lenders.
I simply can't believe that you don't see the absurdity of what you are arguing and am starting to wonder whether it's not because you've made up your mind not to.
I don't know how to get through to you!
"For most everyday purposes, I agree that you can say that you have purchased something using "money". I have distinguished between money and bank credit because there are differences between the two. Withdrawing notes and coins with plastic, and paying with them, is similar. But one important difference is that you don't actually need the notes and coins to even exist to make the plastic payment. In fact, there are purchases which could not be made with cash - for example you couldn't buy BP with cash. It's valued at roughly £77B, and there's currently only £57B of notes and coins".
ReplyDeleteTotally irrelevant!
Money is the medium of exchange. It can be anything.
One party to the exchange has something (BP or a banana, makes no difference) which he wishes to sell..The other party wishes to buy it and in order to do so (leaving aside barter) must offer money for it. That's all there is to it.
Banks are creating 97% of our money out of thin air in the form of interest-bearing debt. 97% of all money, whether used to buy BP or to buy a banana, is created as debt by the banks.
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ReplyDelete"So according to you there have never been any runs on banks and no banks have ever gone bust?"
ReplyDeleteClearly not.
It's important to distinguish between cash flow insolvency (lack of liquidity) and balance sheet insolvency.
Balance sheet insolvency is the more serious. That is where the bank has more liabilities than assets. In that case there is a major problem, because there is simply no way that the bank can pay its creditors.
Cash flow insolvency is when a demand for cash is made, and the bank simply does not have the money to present to the creditor demanding the cash. This is the case in a bank run. But if the bank is still balance sheet solvent, it can sell assets or borrow against them - it can then pay all of its creditors and still be balance sheet solvent.
Cash flow insolvency is much more visible. It becomes very obvious when a bank (or other organisation) is cash flow insolvent because it stops paying its bills.
The point at which balance sheet insolvency occurs is rarely noticed, because it depends on subjective valuations of the bank's assets. Balance sheet insolvency can be hidden for a long time by overstating the value of its assets on its balance sheet, making it look as though it is in good health. But balance sheet insolvency invariably leads to cash flow insolvency, and at that point there aren't sufficient assets to obtain the cash to become cash flow solvent.
"How can you fail to have understood that money placed on deposit is due ON DEMAND? That means, AT ANY TIME OF THE DEPOSITORS' OWN CHOOSING. Of course the banks do not have the means to meet that obligation (as bank runs demonstrate) and of course they know that full well when they pledge themselves to pay that money on demand. That is fraud, pure and simple."
I'm sure you're right right that banks in practice could probably not pay out every deposit in cash if a huge proportion of their depositors came in at the same time. There are simply not enough physical notes and coins to do that. But if a balance sheet solvent bank were to have a run where a huge number of depositors attempted to transfer their money to accounts in other banks, they could do this - they would just need to borrow the money from other banks or the central bank, and then simply transfer that money to the accounts of the other banks. As long as the first bank was balance sheet solvent, the other banks would have no reason to be concerned about lending to the first bank because they would take the first bank's assets as collateral. The first bank's treasury department would be working overtime that day, and it would probably involve lots of talking to the central bank and perhaps the government, just to ensure that things proceeded smoothly, but as long as a bank has sufficient assets to meet its liabilities, there should not be a problem.
A couple of questions for you. Do you know that airlines overbook flights? They do this because they know from experience that a certain proportion of people will not turn up, and don't want to run flights 90% full because it's so inefficient. If too many people turn up for a given flight, the airline might offer accommodation and cash to accept a later flight instead. Would you say that they are committing fraud? That seems to me to be a close analogy to banks.
"I don't know how to get through to you!"
ReplyDeleteI know the feeling... :-)
Look - when intelligent people disagree over something, there's usually something useful for one or both to learn. We've come to this discussion from different backgrounds, thoughts and experiences. We're both convinced we're right, even though we appear to disagree quite profoundly with each other.
As I have said on many occasions, I used to believe that fractional reserve banking was fraudulent, and it took me a lot of thought to come to the conclusion that it was not. What I'm trying to do with this blog is to document how I came to that conclusion. I've found that, for me, considering the balance sheet of a bank is the most helpful way to visualise what is happening.
Banking is not trivial. There are things happening at two different levels - what I'm referring to as money and bank credit in this blog. But I think that a few hours of study is enough for most people to get a good understanding of what is happening, once someone reliable explains it all in one place. My aim is to be that reliable source, who places all the description in one place at a level suitable for people who are interested but don't have a background in banking.
"Banks are creating 97% of our money out of thin air in the form of interest-bearing debt. 97% of all money, whether used to buy BP or to buy a banana, is created as debt by the banks."
ReplyDeleteOne of the disagreements I have with the film "Money as Debt" is its title, which is misleading. Money and bank credit are not debt - quite the contrary. They are created *from* debt. The debt is represented by the government bond or promissory note, and the money or bank credit is exchanged for it.
It seems to me that you are surprised that I am not shocked and outraged that money can be created so easily. I have to admit that I was surprised and disturbed when I first came across the idea, but actually I now find it to be a very reasonable and sensible system. It's quite abstract - the idea of creating "money" from a promise, but as a mathematician and software developer I'm very comfortable with abstract ideas. In practice, what it amounts to is that the value of the money is backed not by lumps of metal, but by the promise of the borrower to produce and sell valuable goods and services in order to repay the debt.
One thing that I find interesting about "Money as Debt" is how it focuses on how easy it is to create money/bank credit, and doesn't really mention how easy it is to destroy it. There doesn't seem to be a suggestion that the bank is losing out in any way when it destroys bank credit.
"I agree. This is why it is essential that the banks should remain solvent i.e. have more assets than liabilities (excluding shareholder equity i.e. the amount owed to the owners). Otherwise the bank couldn't keep its promises"
ReplyDeleteI decide to open a bank. I have £1 million of my own capital to invest. The Horwoodbank has assets of £1 million in cash and liabilities of £1 million (my equity).
I’m now permited to loan out £34 million and on day 1 that is what I proceed to do. The Horwoodbank now has assets of £1 million in cash plus £34 million in IOU's, and liabilities of £34 million in demand deposits plus £1 million in equity.
The Horwoodbank is now technically insolvent because whereas £34 million of its assets are in the form of IOU's which are not due for repayment until after a specified time-interval (stretching, in the case of loans on real estate, to a couple of decades or more) its liabilities can materialize at any time at all. A considerable proportion will be to other banks and will immediately flow out to them. But all the banks are in the APACS system, and their borrowers are doing exactly the same thing and so overall the inflows and outflows roughly cancel-out. Furthermore we can all rely on the Bank of England to tide each of us over periods of temporarily scarce liquidity. So although I have only £1 million in cash with which to meet these demands for payment of up to 34 times that amount my chickens are most unlikely to come home to roost because, in effect, APACS functions as one single big bank, with its own joint account held at the Bank of England.
On day n a new customer (Smith) appears who wishes not to borrow money but to deposit some surplus cash on which to earn interest; he deposits £1 million. Instantly, I am in a position to loan out another £33 million and I do so as quickly as possible. Having done this the Horwoodbank now has assets of £2 million in cash and £67 million in IOU's, and liabilities of £68 million in demand deposits and £1 million in equity. As before, the new money loaned is spent and a proportion of it becomes owed to other banks - but exactly the same reciprocity, under the sheltering skirts of the Grand Old Lady of Threadneedle Street, exists as before and I go merrily on my way.
No distinction is made between that portion of cash balances in deposit accounts which got there by being loaned (ie created out of thin air) and that which was passed across the bank’s counter or was transferred from someone else’s account: all of it is equally available on demand. Smith by now is not of course the only depositor. All actual additional money deposited (ie not created as credit) is immediately included by the Horwoodbank in its reserve and the total sum on loan is kept equal to 34 times the reserve. If Smith or any of the other depositors suddenly decides to withdraw his deposit the Horwoodbank is immediately out of compliance with the required reserve ratio and must take steps to shrink the amount it has on loan - unless sufficient new deposits are made quickly enough. Meanwhile no more loans can be made; where the terms of existing loans permit they may have to be called-in; debtors temporarily in default may have to be foreclosed. But the bank is not closed-down by the authorities, because that might create panic. If panic for any reason does take hold (as in the case of Northern Rock) and all the depositor-holders demand their cash simultaneously - ie there is a run on the bank - the Horwoodbank becomes demonstrably insolvent (which it was in fact all along but nobody twigged before). Even then the government might step in to keep it in business by means of an injection of taxpayers' money.
And you solemnly describe this situation (which is the actual situation all banks, under a fractional reserve system, are always in) as "remaining solvent"? In your determination to defend the system come what may you close your eyes to reality
"If too many people turn up for a given flight, the airline might offer accommodation and cash to accept a later flight instead. Would you say that they are committing fraud? That seems to me to be a close analogy to banks".
ReplyDeleteA false and misleading analogy. Airline tickets are not legal tender. Whether or not knowingly selling more tickets on a flight than there are seats on the plane amounts to fraud I have no idea. Evidently the CPS doesn't believe so or a criminal prosecution would have taken place long ago. As to a claim for damages, that's for a civil court to decide if and when an action is brought.
But all that's irrelevant anyway because your analogy is invalid.
The banks are not prosecuted for fraud either, because a judge erroneously confused bailment with debt and ruled that a deposit of money for safekeeping ceased to be the depositor's property (although it would have been had it been in a safe-deposit box) and became instead the bank's to do with as it liked.
Let's not confuse "law" with "justice": regrettably they are not the same thing. Fortunately, law can (and I devoutly hope will) be changed in order to bring it into closer alignment with justice.
"One of the disagreements I have with the film "Money as Debt" is its title, which is misleading. Money and bank credit are not debt - quite the contrary. They are created *from* debt. The debt is represented by the government bond or promissory note, and the money or bank credit is exchanged for it".
ReplyDeleteI can't comment on this because I've no idea what you're trying to say here. It reads like nonsense to me.
"I’m now permited to loan out £34 million and on day 1 that is what I proceed to do. The Horwoodbank now has assets of £1 million in cash plus £34 million in IOU's, and liabilities of £34 million in demand deposits plus £1 million in equity.
ReplyDeleteThe Horwoodbank is now technically insolvent because whereas £34 million of its assets are in the form of IOU's which are not due for repayment until after a specified time-interval (stretching, in the case of loans on real estate, to a couple of decades or more) its liabilities can materialize at any time at all."
Would you agree that it's not balance sheet insolvent? It has as many assets as liabilities.
Furthermore, it is not cash flow insolvent unless two further things happen: (i) large demands are made for cash by its creditors, and (ii) it is unable to borrow or sell enough to obtain the cash to meet this demand.
If the bank is not balance sheet insolvent, it should always be able to do the latter at least, and so cash flow insolvency should not be an issue. Part of the job of a central bank is to act as a lender of last resort. If the central bank is happy that the retail bank has valued its assets fairly, the retail bank should always be able to access the cash it needs to pay its depositors, because the central bank can create some more to lend to the bank.
Do you consider credit unions to be fraudulent, or at least insolvent? They can't create new bank credit - they simply lend out the money which was deposited with them. If their depositors all try to withdraw their deposits, the credit union will be unable to pay, because most of it has been lent to its borrowers.
robert.horwood said...
ReplyDelete"No distinction is made between that portion of cash balances in deposit accounts which got there by being loaned (ie created out of thin air) and that which was passed across the bank’s counter or was transferred from someone else’s account: all of it is equally available on demand."
This is where I think it's important to do what you referred to as splitting hairs. "Cash balances in deposit accounts" is oxymoronic. A depositor *exchanges* cash for bank credit. And you're right that bank credit obtained by making a deposit is indistinguishable from bank credit created by taking out a loan.
"If Smith or any of the other depositors suddenly decides to withdraw his deposit the Horwoodbank is immediately out of compliance with the required reserve ratio and must take steps to shrink the amount it has on loan - unless sufficient new deposits are made quickly enough."
It does not *have* to reduce loans or attract deposits. It simply needs to obtain sufficient liquidity - it could borrow money, or it could sell some assets such as some of its loans.
"Meanwhile no more loans can be made; where the terms of existing loans permit they may have to be called-in; debtors temporarily in default may have to be foreclosed."
As long as the bank can get sufficient liquidity from the markets or the central bank (as I mentioned above), those things should not be necessary. If they are balance sheet solvent, this should not be a problem. One of the mandates of central banks is to maintain stability, and that would be an obvious case where they would step in - but only to provide liquidity, not a bailout or a subsidy.
"If panic for any reason does take hold (as in the case of Northern Rock) and all the depositor-holders demand their cash simultaneously - ie there is a run on the bank - the Horwoodbank becomes demonstrably insolvent (which it was in fact all along but nobody twigged before)."
The problem with Northern Rock was that it was widely suspected that it was balance sheet insolvent, not just cash flow insolvent. In that situation, a run on the bank is entirely logical, because once the money has gone, there's nothing left for the others.
If Northern Rock had been balance sheet solvent, it would have been able to borrow money from the markets, using its assets as collateral. The fact that it failed suggests that potential lenders thought that the value of the 125% loan-to-value mortgages that it had been lending were overstated on Northern Rock's balance sheet.
"Even then the government might step in to keep it in business by means of an injection of taxpayers' money."
I am disgusted with the way that governments have been doing that. If a bank is balance sheet insolvent, it must be wound up, and the ones who invested in it or bought its bonds should be the ones to take the losses. As far as I am concerned, forcing the taxpayers to pay for the bank's losses is theft. It should never even have been allowed to get to the point where anyone other than the shareholders lost money. That's the whole point of having capital - so that only the owners lose when the bank makes bad decisions. But it requires regulators to seize the bank once its capital buffer gets too small.
robert.horwood said...
ReplyDelete"And you solemnly describe this situation (which is the actual situation all banks, under a fractional reserve system, are always in) as "remaining solvent"?"
Yes, I do describe it as remaining solvent. Being balance sheet solvent allows a bank to be cash flow solvent, because it has assets which it can sell or borrow against.
"In your determination to defend the system come what may you close your eyes to reality "
I'm defending the idea of money created from debt and fractional reserve banking. I'm certainly not defending the current set of banks, many of which appear to have lent very badly and made themselves balance sheet insolvent.
My main concern is that there are a number of sources blaming the current monetary system, and implying that if we only changed it, e.g. by having a state monopoly bank, or not allowing the charging of interest, or stringing up all the people working in banks, that we would somehow solve all our problems. It feels to me that we're being distracted from the stories about banks lending to people that they *knew* could not repay, but did it anyway to make short-term bonuses. It was that behaviour that caused the financial crisis, not the system itself.
If the current or a future government were to abolish fractional reserve banking, lots of people would cheer, but without the guilty people being tried and punished, those very same people will proceed to find ways to abuse the new system and we'll be even worse off.
robert.horwood said...
ReplyDelete""If too many people turn up for a given flight, the airline might offer accommodation and cash to accept a later flight instead. Would you say that they are committing fraud? That seems to me to be a close analogy to banks".
A false and misleading analogy. Airline tickets are not legal tender."
I know they're not legal tender, but it's an *analogy*. Your argument appeared to be that banks might not be able to meet demands for cash, and that was therefore fraudulent. Now you suggest that it's ok with airline tickets because they're not legal tender. What about if it was, say, gold which you'd deposited somewhere? That's not legal tender.
robert.horwood said...
ReplyDelete""One of the disagreements I have with the film "Money as Debt" is its title, which is misleading. Money and bank credit are not debt - quite the contrary. They are created *from* debt. The debt is represented by the government bond or promissory note, and the money or bank credit is exchanged for it".
I can't comment on this because I've no idea what you're trying to say here. It reads like nonsense to me."
Robert - while it's an interesting discussion, your tone continues to feel both hostile and impolite to me.
"Money as debt" suggests that the money *is* debt. But it is not. When someone borrows money from a bank, and spends it, the resources which belonged to the bank are being used to make that purchase for the benefit of the borrower. It seems obvious to me that the borrower is therefore in debt to the bank. Why is that such a problem? When you borrow something, you're in debt. Then you pay it back, and you're not in debt any more.
robert.horwood said...
ReplyDelete"The banks are not prosecuted for fraud either, because a judge erroneously confused bailment with debt and ruled that a deposit of money for safekeeping ceased to be the depositor's property (although it would have been had it been in a safe-deposit box) and became instead the bank's to do with as it liked."
Can you tell me more about this case? Which country was it in? If the depositor was not happy to have the money lent to someone else, why did he not put it in a safe-deposit box? Isn't it good that banks offer both services? As long as the depositors know what happens in each case of course.
"I'm defending the idea of money created from debt and fractional reserve banking".
ReplyDeleteOK, message understood. You've never actually said that in so many words before, although of course it wasn't too difficult to guess from your arguments.
You had, however presented yourself (consciously or not, I don't know) as an objective (aka unbiased, uncommitted) searcher after "the truth" (my words not yours), whereas now you have acknowledged that you are engaged in advocacy on behalf of FRB, because you've become convinced of its rightness (my word again, for want of a better). I'm not criticising that. Everyone's entitled to their views. It's just nice to know where everyone stands.
Shall we agree to drop the airline-ticket analogy - I don't think it's getting us anywhere, do you? Analogies can be slippery things at the best of times.
"Can you tell me more about this case? Which country was it in?"
There was a series of pivotal cases, in England. But it would be pointless for me to try to enlarge on them here when that's been better done elsewhere. If you really want to know more, I can only repeat my suggestion that you download Rothbard's book. The salient arguments are summarized there (pp 85-104), accompanied (of course) by Rothbard's commentary - which you may not find to your liking but then you don't have to agree with it.
I have reached the opposite conclusion from you. I believe FRB has done and is doing untold harm. I think that banking should, by law, be forced to revert to something much closer to what it began by being, specifically that loan banking and investment banking should be completely divorced activities, with loan banks being required to maintain 100% reserves. I think that our money should continue to be fiat money and that its issuance should be returned to the nation's treasury, the quantity issued being regulated by a new embodiment of the MPC (ie not by the politicians) in accordance with laid-down objectives. In short, I'm strongly in favour of "the (proposed) Bank of England Act" in all its particulars.
"Do you consider credit unions to be fraudulent, or at least insolvent?"
I don't consider them to be fraudulent because (if I understand correctly) they are not-for-profit mutual societies in which all the members are party to the way the operation is conducted and nobody is in any danger of misunderstanding the true situation. One member on his own could not cause insolvency; that would require concerted action by a significant number. What would be the point of destroying their own mutual society, which they only joined because they believed in the idea? But I suppose it could happen.
robert.horwood said...
ReplyDelete""I'm defending the idea of money created from debt and fractional reserve banking".
OK, message understood. You've never actually said that in so many words before, although of course it wasn't too difficult to guess from your arguments.
You had, however presented yourself (...) as an objective (...) searcher after "the truth" (my words not yours), whereas now you have acknowledged that you are engaged in advocacy on behalf of FRB, because you've become convinced of its rightness"
I am certainly a searcher after the truth. It is extremely important to me. I don't believe that I am advocating on behalf of FRB, but FRB is what we have now and it seems sensible to me to start the search for truth by describing FRB and then investigating the claims which have been made about it by "Money as Debt", "Zeitgeist Addendum", and "The Creature from Jekyll Island". I've got two more posts half-completed - one on the creation of money (that is cash and deposits at the central bank), and one on interest. Once I complete the interest one, I hope that that will convincingly debunk the claim that FRB necessitates an exponentially-increasing money supply. At that point, I will have achieved my first major target.
The next target will probably be moving on from the banking system to macroeconomics. Just looking at what can be said with certainty, and what is a matter for opinion and priority.
I haven't decided exactly where to go after that yet, but I might compare FRB with alternatives, examining the advantages and disadvantages of each. I might comment on and analyse stories which I read in the news (which I'd have loved to do during the election, because there were some truly bizarre things being said by the various political parties). It's several weeks off yet anyway.
I'll use another comment to respond to the remainder of your comment.
"If you really want to know more, I can only repeat my suggestion that you download Rothbard's book."
ReplyDeleteWhat that "What Has Government Done to our Money?"? I can't find your earlier comment mentioning it now.
I'll see if I can find a copy.
"I think that banking should, by law, be forced to revert to something much closer to what it began by being, specifically that loan banking and investment banking should be completely divorced activities"
Well I completely agree with that. The speculative proprietary trading going on at banks should not be allowed where the money being used is guaranteed by a government scheme. But do remember that HBoS and Northern Rock got into trouble, just as much as RBS. They were primarily retail banks, who look like they compromised their underwriting standards in order to make themselves look more profitable (in the short term at least). It's not a case of retail banks good, investment banks bad.
"with loan banks being required to maintain 100% reserves"
I don't think that's possible is it? That would be what the Bank of England Act 2010 calls transaction accounts which are not loaning the money at all - they're simply storing it at the Bank of England. I think it's an excellent idea to have such an account by the way - I'd love to have one at the moment. The only way at the moment for a normal person to hold what I've called money is in the form of cash. If we could all have an account with the Bank of England, we could guarantee to preserve our savings in the event of bank collapses (minus inflation). In fact, until just a few years ago we used to be allowed to have exactly that - an individual could hold a Bank of England current account, but the BoE decided to stop that facility entirely for reasons which are not entirely clear.
"I think that our money should continue to be fiat money and that its issuance should be returned to the nation's treasury, the quantity issued being regulated by a new embodiment of the MPC"
My gut feeling is that giving more power to H.M. Treasury is troublesome. They already have a lot of power, and this appears to give them even more.
"In short, I'm strongly in favour of "the (proposed) Bank of England Act" in all its particulars."
I've browsed the web site a couple of times, after finding links to it from comments in Robert Peston's BBC blog. While I agree with some of their ideas, such as a pure transaction account, I'm sceptical of some of their assertions which they use to justify their conclusions. They essentially say "it's all the fault of FRB and private money creation", without actually justifying that claim. I'm also sceptical that the Bank of England would ever tell the government that it had to tax money and hand it to the BoE to be destroyed if the real economy were to shrink.
Finally, I'm concerned at the additional concentration of power in the hands of central government. Essentially, any time the wealth of the nation increases due to the actions of individuals and companies, it's the central government which gets a load of new money to spend as it sees fit. It's a tax on wealth creation. And then there's the political pressure that the government would put on the MPC behind the scenes just before an election under such a scheme.
robert.horwood said...
ReplyDelete""Do you consider credit unions to be fraudulent, or at least insolvent?"
I don't consider them to be fraudulent because (if I understand correctly) they are not-for-profit mutual societies in which all the members are party to the way the operation is conducted and nobody is in any danger of misunderstanding the true situation."
But they do lend out the money that is deposited with them, so they can't pay back the depositors on demand. They would have to call in the loans. I'm pretty sure that they can't borrow against the loans in the capital markets either, so they're potentially even more prone to cash flow insolvency than the retail banks.
"One member on his own could not cause insolvency; that would require concerted action by a significant number."
If we're talking insolvency as you described it before, where you consider a bank essentially always insolvent because it doesn't have enough cash to pay its depositors, then as soon as a credit union lends money it becomes insolvent. Now I don't consider it insolvent, any more than I consider a balance sheet solvent bank lending with a 10% money reserve, but the point that I am trying to make is that FRB is not qualitatively different from a credit union, just quantitatively.
I think that a single borrower could cause a credit union to become balance sheet insolvent, particularly in the early days. When a credit union starts, it has no reserve, and it has to build one up from its profits. If a borrower defaults on a loan greater than the reserve, which is more likely in the early stages, then the credit union is now insolvent. Lending at 12% per annum interest, it has to be certain that no more than 1/9 of the amount it lends is defaulted in the first year.
"If you really want to know more, I can only repeat my suggestion that you download Rothbard's book."
ReplyDeleteWhat that "What Has Government Done to our Money?"? I can't find your earlier comment mentioning it now.
I'll see if I can find a copy".
No, it was "The Mystery of Banking", available as a .pdf file from http://mises.org/ (just do a search on that site)
"I've browsed the web site a couple of times... While I agree with some of their ideas, such as a pure transaction account, I'm sceptical of some of their assertions which they use to justify their conclusions. They essentially say "it's all the fault of FRB and private money creation", without actually justifying that claim".
ReplyDeleteWith respect, I think you've simply failed to understand the proposal. I say this because the words quoted above are, frankly, a travesty. I really think you owe it to yourself if (as you say) the truth is extremely important to you, to study thoroughly that very carefully-constructed and detailed proposal before you so off-handedly dismiss it in the way you do here. (And I would make the same observation about Rothbard's book if you decide to read all of it).
Furthermore, the website is interactive. The people behind it encourage the putting of questions and making of comments - which are replied-to. Why don't you give voice to your criticisms there and afford them the opportunity either to rebut your criticisms or accept them?
"I'm also sceptical that the Bank of England would ever tell the government that it had to tax money and hand it to the BoE to be destroyed if the real economy were to shrink".
I think your syntax has got slightly garbled here - did you really mean "tell the government that it had to tax money"? Because that's not what the proposal says; and how does one "tax money"? The proposal currently doesn't discuss (and that will be one of my criticisms of it if the proposers don't correct the omission themselves) reduction in the money-supply, only increases. Depending upon what monetary target were to be set, under certain economic conditions digital money might have to be destroyed. This would be done by reducing the amount credited to the 'Central Government account' at the BoE, and the government would in consequence be forced to alter its taxation or spending plans, or both.
"Finally, I'm concerned at the additional concentration of power in the hands of central government. Essentially, any time the wealth of the nation increases due to the actions of individuals and companies, it's the central government which gets a load of new money to spend as it sees fit. It's a tax on wealth creation. And then there's the political pressure that the government would put on the MPC behind the scenes just before an election under such a scheme".
My comment on this is the same as that made above:- the site invites such criticisms to be put. Why not take up the challenge?
'"with loan banks being required to maintain 100% reserves"
ReplyDeleteI don't think that's possible is it?'
Your comment leaves me at a complete loss. For approximately 200 years the Bank of Amsterdam did exactly that.
What more can I say?
"My gut feeling is that giving more power to H.M. Treasury is troublesome. They already have a lot of power, and this appears to give them even more".
ReplyDeleteBut is mere "gut feeling" enough?
Moreover, I was just paraphrasing. If you study the proposal you'll see that it doesn't invest the Treasury with any additional powers. I was merely using that label to give a locus to where money would issue from. That's a detail: what's important is who decides how much is to be issued.
"But they do lend out the money that is deposited with them, so they can't pay back the depositors on demand. They would have to call in the loans. I'm pretty sure that they can't borrow against the loans in the capital markets either, so they're potentially even more prone to cash flow insolvency than the retail banks".
ReplyDeleteI don't dispute that.
But it was you who introduced credit unions into this debate. I look upon that as a diversionary tactic and not a serious argument about the merits or otherwise of fractional reserve banking. Credit unions represent a minute proportion of banking activity and are, frankly, a small and potentially distracting detail (like airline tickets).
For someone who doesn't see himself as being engaged in advocacy you seem surprisingly ready to engage in such tactical gambits if I may say so.
The members of credit unions see themselves as having an interest in keeping them going because they are committed to the social purpose they look upon them them as serving. That alone puts them in a separate category, obeying different imperatives (moral and social ones), from the banks we are discussing here.
I'm not prepared to disuss them any further.
An afterthought to this:-
ReplyDelete"What more can I say?"
made apropos of 100% reserves.
Again, I was paraphrasing, relying upon the detailed exposition given on the website.
'Transaction accounts' would be lodged with the BoE (via individual banks not personally). By virtue of that fact they would automatically become backed 100%, and at the same time become unavailable for the banks to use for lending on or for speculation.
"100% reserve banking" is thereby achieved (in digital form, as opposed to physically backed with money or gold sitting in banks' vaults as was the case with the Bank of Amsterdam in the 17th and 18th centuries).
But this is all spelled out in the proposal and questions about it can be put.
Re. the Bank of Amsterdam:
ReplyDeleteI was in error. It was not a loan bank, but a deposit bank.
More importantly, you are of course correct in saying that 100% reserve banking would be impossible in respect of loan banking. But that is not being proposed, and if I mistakenly gave that impression I'm sorry.
However the "proposed BoE Act" website does make this quite clear.
Loan banking would remain, as now, an investment activity and losses (if any) would be borne by the investors and shareholders. It would be completely segregated from deposit banking.