The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.
Related:
Over at The Cobden Centre, my colleague Dr Anthony J Evans sets out a summary of his proposal for banking reform, derived from work by Kevin Dowd and Richard Salsman.
He first sets out the problems of the current situation in this graphic:
He goes on to explain how to deliver a return to Free Banking.
Anthony’s proposal, though informed by many of the same ideas, differs from that of Jesus Huerta de Soto by taking a different path to a similar end point and by allowing fractional reserves. It is an important contribution to the debate.
For a staggeringly radical and truly libertarian alternative, see Monetary Reform – The Case for Button-Pushing by Philipp Bagus. As Philipp writes, “It can serve as a standard for comparison.”
In the course of scheduling a series of articles for The Cobden Centre on the Theory of Money and Credit, I found this quote which seems apposite after our recent spell of “quantitative easing”, the injection of new money into the economy, also known in some circles as inflation of the money supply:
A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, i.e., of antidemocratic, policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. It explains why inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. When governments do not think it necessary to accommodate their expenditure to their revenue and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism.
Emphasis mine.
The Institute of Economic Affairs critiques New Lib Dem proposals – tax prudent banks to shore up risky ones:
I welcome Vince Cable’s repudiation of the Tobin tax but, instead, he has proposed a tax on bank profits to help provide a sort of insurance premium to pay for the losses banks impose on the taxpayer when they go bust. It would be better to have other reforms to ensure that a “no bail out” pledge can be made credible, but let’s assume that we are starting from here, what is wrong with Vince Cable’s proposal?
I subscribe to the view that our present economic and financial woes were caused by the government. Via The Cobden Centre, you can see we are working on doing something about it:
Through tomorrow and Saturday, ESCP Europe and The Cobden Centre are hosting a Colloquium on Sound Money. The Colloquium is to be directed by Founding Fellow Dr Anthony J Evans and chaired by Corporate Affairs Director, Steve Baker.
A team of academics, banking professionals, entrepreneurs and politicians will meet to discuss:
- What is Money?
- The Interest Rate and Intertemporal Coordination
- The Gold Standard and the Great Depression
- Deflation and Prosperity
- Free Banking vs 100% Reserves
- Central Banking
- Proposals for Reform
The authors whose work will be under consideration are Carl Menger, Joseph Salerno, Frank Shostak, Ludwig von Mises, Friedrich A Hayek, Joan and Richard James Sweeney, Murray Rothbard, Lawrence Reed, Lawrence H White, George Selgin, Vera Smith, Tim Congdon, Richard Salsman and Jesús Huerta de Soto.
My Cobden Centre colleague and Chief Executive of Tyler Capital, James Tyler, explains how we came close to financial collapse and what to do about it:
Fractional Reserve Banking (FRB) is an inherently unstable complex system.
Each and every bubble and crisis has some kind of link to FRB, going back thousands of years.
Even where financial crises are caused by natural disasters (the San Francisco earthquake of 1906 being a prime example), the financial crisis only followed because banks did not have enough reserves to pay out worried depositors – due to fractional reserves.
In a nutshell, depositors wanted what they thought was their property back, only to find it did not exist.
Over 70% of people in the UK believe that money placed in an instant access account remains their property. This is not the case.
Read more: How to avoid future encounters with financial meltdown » The Cobden Centre.
Over at The Cobden Centre, my friend and colleague, financial engineer Gordon Kerr, explains how to destroy the British banking system through the use of derivatives which take advantage of the regulatory system, then sets out four measures to solve the problem:
Nine years ago I worked as a structuring engineer in a three-man team within the investment banking unit of a major British bank. One of us was very bright. He stunned me one day with an idea as to how we could:
Produce immediate (but illusory) substantial profits for our bank, thus ensuring that we would enjoy generous personal remuneration;
Generate ‘virtual’ share capital to boost our bank’s capital reserves;
Leave the actual investment risk exposure and profit expectation of our bank almost exactly the same after the transaction as before it.
Was this idea the kind of rocket science derivative engineering that justifies master of the universe labels for the three of us who designed and implemented it? No: it was extremely simple. Here’s how it worked. We transmuted some loan assets into a derivative transaction for regulatory purposes, whilst leaving the actual loan arrangements unaltered.
A stunningly good article by my Cobden Centre colleague Dr Anthony J Evans which is now being picked up in the blogosphere:
Barack Obama’s speech on Monday to Wall Street outlines an overhaul of the regulatory regime. On the anniversary of the bankruptcy of Lehman Brothers, politicians from both sides of the Atlantic are looking to remodel capitalism. The thirst for greater regulation is strong, united around Gordon Brown’s judgment that “laissez-faire has had its day … the old idea that the markets were efficient and could work themselves out by themselves are gone”.
The notion that the present financial system is “laissez-faire” is, of course, ludicrous. At present, we have a nationalised organisation that holds a state-granted monopoly on the issuance of currency. If this were any industry other than finance, the Bank of England would be seen as the Soviet-style planning board that it is.
Defending laissez-faire is therefore not a defence of the status quo; it is a positive prescription for a totally new regime.
Read the rest of the article: Don’t regulate banking – liberalise it.
Further reading here: Insight.
Drawing on the work of Nobel Laureates in economics from three traditions, plus numerous other distinguished scholars, Cobden Centre Chairman, economist and successful entrepreneur Toby Baxendale presents an informal introduction to our proposal for honest money and the benefits consequent on the reform. See also our precis of Irving Fisher’s 100% Money.
via A day of reckoning: how to end the banking crisis now » The Cobden Centre.
I have been busy with my colleagues at our new educational charity for honest money: Steve’s posts at The Cobden Centre.
See also:
Via The Cobden Centre » Honest money, a summary of economist Irving Fisher’s “100% Money”:
The 100% proposal is the opposite of radical. What it asks, in principle, is a return from the present extraordinary and ruinous system of lending the same money 8 or 10 times over, to the conservative safety-deposit system of the old goldsmiths, before they began lending out improperly what was entrusted to them for safekeeping. It was this abuse of trust which, after being accepted as standard practice, evolved into modern deposit banking.
Via FT.com / Companies / Financial Services – Nomura has Lehman’s old crown in sight:
Ten months ago when Lehman Brothers collapsed, it would have been a stretch to suggest that the former investment bank might reclaim its crown as the biggest broker on the London Stock Exchange.
But on Monday the new owner of its European equities trading business, Nomura of Japan, said its newly constituted European equities arm was now the LSE’s third-largest broker, behind Credit Suisse and top-ranked Merrill Lynch.
Via British banks highly vulnerable to future shocks, Bank of England warns – Telegraph:
Britain’s banks remain over-indebted, highly vulnerable and harbour growing funding gaps which leave them susceptible to future shocks, the Bank of England has said.
…
In a sign of the strain facing nations’ public finances – including the UK’s – the report also revealed that the threat of a sovereign debt default has become one of the biggest concerns for investors. A survey put together for the report identified sovereign risk as a financial stability concern for the first time.
The report also laid out a number of key criteria banks will have to fulfil in the future – reforms which could transform the structure of the financial system. Among its recommendations were that in future banks should “face a credible threat of closure or wind down”, should have a “risk-based, pre-funded deposit insurance system”, should increase their levels of capital and liquidity, depending on their size, and should provide a “will” which explains how to dismantle them in the event of insolvency.
The Bank of England’s Financial Stability Report is available here. The summary is quite accessible.
However, to answer the underlying “why?” one must look elsewhere. It may also be worth considering this speech by the Earl of Caithness:
The Banking Bill which we are currently discussing in the House is very complex and detailed, but it does nothing to resolve the current banking crisis, which lies at the heart of our economic problems. … the fault that really needs correcting is our whole banking system.
The debate which must be reopened and made contemporary is that between the Banking and Currency Schools of the nineteenth century. At the time of the 1844 Bank Charter Act, the Currency School committed three errors which haunt us today. More to follow at The Cobden Centre.
I am delighted to report that I have established The Cobden Centre, an educational charity for honest money and social progress, together with founder Toby Baxendale. You can find out more at our web site. The Cobden Centre provided this site’s previously-published reading list, Rethinking Economics.
Over the coming months, The Cobden Centre will provide a number of insight articles drawing on our extensive base of literature and covering, as a beginning, the scope of de Soto’s Money, Bank Credit and Economic Cycles:
Please follow me, subscribe to new articles and keep an eye on the Cobden Centre site.
The European Commission and other EU officials are celebrating after the Prime Minister accepted on Thursday night the creation of European supervisors over national regulators.
Senior EU officials described how in return for a promise that Brussels regulators can not have power to tell the British government when, and by how much, to bail out banks, Mr Brown has given ground on a broad range of other supervisory powers.
via Gordon Brown surrenders key powers over financial regulation to Brussels – Telegraph.
See also King seeks empire and EU ‘risks lagging US on regulation’.
A couple of quotes from De Soto, pp 456-474.
From “Effects the business cycle exerts on the banking sector”:
Hence we can conclude that an inherent trend in the privileged exercise of fractional-reserve banking leads to bank consolidation and encourages bankers to develop and maintain close relations with the central bank as the only institution capable of guaranteeing banks’ survival in moments of crisis, situations banks themselves create regularly. Furthermore the central bank directs, orchestrates, and organizes credit expansion, making sure that banks expand more or less in unison and that none stray far from the established pace.
Eerily familiar… and for fun, from “Marx, Hayek and the view that economic crises are intrinsic to market economies”:
To contend that an economy of real socialism offers the advantage of eliminating economic crises is tantamount to affirming that the advantage of being dead is immunity to disease.
De Soto goes on to provide a clear and detailed solution which he claims could provide stable and gently growing constant prosperity.
Following the collapse of BankUnited:
Regulators have worried that sales of troubled banks to private capital should not look overly generous. Those fear were fed when Chris Flowers, founder of private equity firm JC Flowers, said the investor group that bought IndyMac’s assets had all the upside for the failed California bank, while the government had all the downside. Calls to Mr Flowers were not returned.
via FT.com / Companies / Banks – Private equity consortium wins BankUnited auction.
“The government had all the downside”? The taxpayer, surely? No government should socialize business risk.
Present economic circumstances seem perilously close to those described by scholars of the monetary theory of the trade cycle:
The Bank of England has pledged to pump another £50bn into the economy as it steps up efforts to haul the UK from its worst recession in at least two decades.
via Bank of England to pump another £50bn into economy as it steps up recession fight – Telegraph.
China has given its clearest warning to date that emergency monetary stimulus by Western governments risks setting off worldwide inflation and undermining global bond markets.
via China fears bond crisis as it slams quantitative easing – Telegraph.
Continuously injecting additional amounts of money where it creates temporary demand, together with an expectation of continuously rising prices, draws labour and resources into use in areas which will last only as long as the supply of new money.
Read more posts on economics.
Bank of America, Citigroup and Wells Fargo will have to collectively find $55bn in fresh ordinary capital as a result of the US Treasury’s financial stress tests, details of which are due to be announced today.
The three banks – three of America’s four largest by assets – are expected to be among the institutions requiring the most capital following the publication of the long-awaited tests, designed to ascertain whether banks’ reserves are strong enough to survive further economic shock waves.
Lloyds Banking Group, which is 44 per cent owned by the UK taxpayer, today warned that soaring bad debt from legacy HBOS customers will contribute to a 50 per cent rise in loan book write-offs in 2009 compared to last year.
…
Mr Daniels pointed out that its bad debts would be largely taken on by the taxpayer after Lloyds last month outlined an agreement to join the Government Asset Protection Scheme.
Under the scheme, Lloyds will transfer £260 billion worth of its most high risk loans to the Government. Lloyds will bear the first losses on loans up to £25 billion, with any further writedowns being taken by the taxpayer.
via Lloyds bad debts to soar 50% on HBOS loans – Times Online .
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