Saturday, 19 January 2019

Banks are not intermediaries?

It has become fashionable recently to claim banks are not intermediaries, i.e. apparently they don’t collect savings from savers and lend on those savings to borrowers. E.g. see here, here, and here.

If that’s the case, one has to wonder why banks have dished out billions over the last fifty or hundred years to depositors and bond-holders by way of interest: the object of the exercise is to attract money from depositors and bond holders isn't it? But if banks do not need that money before making loans, why dish out those billions?

It could perhaps be argued in the case of depositors that the object of the exercise is to grab customers with a view to then selling those customers the other services, like supplying credit cards, mortgages, administering current accounts (“checking accounts” in US parlance). I.e. the interest paid on some current accounts is perhaps a loss leader.

But that argument is doubtful. Supermarkets go in for the loss leader trick, but the actual loss leader items change from one year to the next and from supermarket to supermarket. That is, in one year supermarket A may offer cut price baked beans, while supermarket B offers cut price fruit. Then next year A will try “buy one get one free” for some items, while B will try cut price beer.

In contrast, while some banks have paid no interest on instant access accounts in recent years because of the fall in interest rates over the last twenty years or so, they INVARIABLE pay interest on one or two month term accounts. That makes it look like the latter interest is not just some sort of cheap trick designed to pull in new customers.

Plus in the case of bond-holders, the loss leader idea is as good as irrelevant. That is banks do not sell bonds with a view to turning bond-holders into purchasers of other products.

The reality is that a bank cannot simply lend out millions willy nilly without somehow or other having money FLOWING IN, otherwise the bank will run short of reserves and will have to go cap in hand to other banks or the central bank with a view to borrowing reserves.

But that’s not to say a bank has to have exactly $X dollars flowing in for every $X flowing out in the form of loans. I.e. banks do have some leeway. That is, to a limited extent, they can lend money without having any corresponding amount of money flowing into their coffers. But if a bank goes too far in that direction, that means, to repeat, it will have to borrow reserves, something banks do almost every day. But amounts borrowed that way are small compared to their total assets or liabilities.

So I suggest that rather than claim banks are not intermediaries, it would be more accurate to say that basically they are intermediaries, but that they have limited scope for acting in what might be called a  “non intermediary” fashion

Friday, 18 January 2019

The flaw in deposit insurance.

Those who place money with a bank with a view to the bank lending on their money so as to earn them interest are protected by taxpayer backed deposit insurance, which is nice for them. But if people who want to lend out their money via banks are protected against loss gratis the taxpayer, why shouldn’t those who place their money with other investment intermediaries (e.g. unit trusts, mutual funds, private pension schemes, etc) enjoy the same privileges (where that’s what investors want)?

Unless other investment intermediaries enjoy the same luxury, deposit insurance is a form of discrimination in favour of, i.e. a subsidy of banks.

Moreover, the argument put for the existing bank system and deposit insurance by the UK’s Independent Commission on Banking (sections 3.20 – 3.24) namely that deposit insurance encourages lending and investment applies equally to other investment intermediaries.

On the other hand, the availability of a totally safe method of storing and transferring money is a basic human right, so it’s fair enough to have taxpayers stand behind THAT system. So what to do?

Well I suggest there is a very simple and widely accepted principle that helps sort this out: it’s the widely accepted principle that it is not the job of governments or taxpayers to stand behind COMMERCIAL ventures or transactions (as I argue here).

Depositing money with an investment intermediary with a view to earning interest is clearly a COMMERCIAL transaction, and should therefor not be protected by taxpayers / governments.

In contrast, the simple act of storing money and transferring it is not necessarily commercial in nature. But even where it is commercial in nature, the country’s money storage and transfer system cannot possibly be allowed to collapse. Thus there is a case for taxpayer / government insurance of that system.

And what d’yer know? That’s exactly what full reserve banking achieves. That is, under full reserve, those who want their money to be loaned out so as to earn interest are not protected, while those who simply want money STORED without earning interest are protected.

And as for any deflationary effect of the cut in lending that full reserve would bring, that’s easily countered by standard stimulatory measures, e.g. the suggestion made by Keynes in the early 1930s, namely that in a recession, government should simply create new money and spend it (and/or cut taxes). The net effect would be less lending and thus less debt, and given that the great and the good and every windbag in the country keeps going on about the excessive amount of private debt, what’s the problem?

Sunday, 6 January 2019

Why QE green bonds?

Richard Murphy and Colin Hines propose a “National Investment Bank” in the Guardian which issues “Green Bonds” which the Bank of England then “QEs”: i.e. the BoE prints money and buys up those bonds.

The trouble there is that having government or any nationalised institution (like a National Investment Bank or government itself) issue bonds with the BoE then buying back those bonds is that that all nets out to “government prints money and spends it” (sometimes known as “overt money creation” – OMC).  So why not do the latter and not bother with the investment bank or green bonds?

In contrast, I can see the point of green bonds which are not QEd: people with money to spare might be prepared to do a bit for the environment by lending to green projects at a rate of interest below the going rate on bog standard government debt.

Friday, 4 January 2019

A brief 200 word history of banking.

Several centuries ago, bankers thought up a trick, namely to accept deposits from customers and lend on relevant money, while telling depositors their money was 100% safe.

That of course is fraudulent: reason is that loaned out money is never totally safe. And indeed that fraud becomes blatantly obvious when the inevitable happens: banks fail, or the entire bank system looks like failing.

But the latter fraud brings bankers great riches, and as long as you’re rich, the establishment will see you as respectable. You can earn your millions from drug dealing, extortion, or a chain of brothels. It really doesn’t matter: long as you’ve got loads of dosh, the establishment (i.e. politicians, bank regulators, academic economists, the British royal family, the Church of England, etc) will see you as respectable. For example the going price for a seat in the UK House of Lords is about a million pounds.

So instead of clamping down on the above fraud, the establishment comes to the rescue of commercial banks and assists in the above fraud. That is, commercial banks are rescued, plus they are  protected via deposit insurance, the “too big to fail” subsidy, and so on.

“Generous” donations by bankers to politicians’ “election expenses” assist politicians to see sense in connection with the above matters.

Net result:  bankers laugh all the way to the bank, if you’ll excuse the pun.

Monday, 31 December 2018

How come human beings can talk?

The German economist Heiner Flassbeck highlights the fact that human beings are largely incapable of distinguishing between two senses of the same word: in particular, in his native German language, the word for debt is the same as the word for guilt. That means Germans tend to think that debtors are all guilty: totally illogical of course.

Much the same goes for the word “austerity” which has two quite separate meanings: first, inadequate demand, and second, inadequate public spending (even assuming demand is adequate). About 99% of English speakers who use the word fail to clarify in what sense they are using it. But that doesn’t really matter for them. After all, they’re not really interested in solving austerity related problems (in any sense of the word). Normally the motive for wielding the word is to do some so called “virtue signalling”.

In view of the above failure to understand or use words properly, it’s a wonder is that human beings can talk at all…:-)

Incidentally Heiner Flassbeck and yours truly published (quite separately) a possible solution for Greece and similar countries a year or two ago. That’s to let Greece impose import tariffs. See here.

However, there’s been little interest in that idea, and for reasons alluded to above, namely that Greece is a godsend for virtue signallers. In contrast, if you suggest an actual solution for the Greek problem which requires a concentration span of more than five seconds to get to grips with, then virtue signallers’ eyes glaze over.

And that’s the end of this thoroughly cynical article.

Sunday, 23 December 2018

Why should money lenders be backed by taxpayers?

Under the existing deposit insurance system, people who deposit money at banks with a view to having their money loaned out by their bank are guaranteed against loss by taxpayers. With a view to explaining the flaws in that system, let’s start by considering money and banks from first principles.

1. “Money is a creature of the state” as the saying goes. That is, there has to be general agreement in any country as to what the country’s basic form of currency will be. Plus there has to be some sort of state controlled organisation to issue that currency. Reason is that if too much is issued, excess inflation ensues and if too little is  issued, there is  excess unemployment. (I’m assuming the currency comes in fiat form as is normal nowadays and let’s assume the currently unit is a “dollar”. Plus I’ll assume that the “state controlled organisation is a “central bank”).

2. Assume a hypothetical economy which is switching from barter to money for the first time and that at least initially, commercial banks are barred from issuing money. In that scenario, people and firms will borrow from and lend to each other, sometimes direct person to person (or firm to firm etc) and sometimes via commercial banks.

3. Where depositors choose to have their money loaned on by commercial banks it would be fraudulent of banks to promise those depositors they are guaranteed to get their money back and for the simple reason that loaned out money is never totally safe (although that sort of promise was common prior to WWII: in the 1920s and 30s the fraudulent nature of that promise became blatantly obvious when ordinary depositors lost billions as a result of the hundreds of banks collapsing in the US. So given that those depositors stand to make a loss, they are not actually depositors: they are more in the nature of shareholders in relevant banks.


4. A possible optional extra to the above arrangement is to let commercial banks create and lend out their own home made money, as occurs in the real world at present. Those DIY dollars take the form of promises by relevant banks to pay money to whoever.

5. However, that DIY money does not really comply with normal definitions of the word money unless it is guaranteed by taxpayer / government backed deposit insurance. That is, if that DIY money is NOT BACKED in that way, then such “money” is in effect equity / shares as explained above.

6. Now what’s wrong with depositors wanting to have their money loaned on with the risk being carried by some sort of deposit insurance, particularly if that insurance system is run on commercial lines, i.e. assuming it pays for itself? Well the problem is that if people who deposit money at banks with a view to the bank lending on their money are entitled to deposit insurance, what about those who deposit money at any other investment intermediary like a stockbroker or unit trust (“mutual funds” in the US) with the same end in view, i.e. earning interest or dividends?

7. Another popular excuse for deposit insurance is that such insurance boosts the banking industry. Indeed that was the excuse given by the UK’s Independent Commission on Banking (sections 3.20 to 3.24). They claimed deposit insurance encouraged borrowing, lending and investment. (Actually the way the ICB put that point was to say that if deposit insurance WAS WITHDRAWN “the economic costs would be very high.” But that’s the same as saying deposit insurance boosts the economy and withdrawing it harms the economy.)

8. Moreover, the ICB were vague on exactly what form the alleged “costs” would take. For example, if they were trying to suggest the decline in borrowing due to a withdrawal of deposit insurance would raise interest rates and thus cut demand, that is not much of an argument: reason is that any fall in demand can be countered simply by having government and central bank create more base money and spend it into the economy (and/or cut taxes).

Plus current very low interest rates are not an unmixed blessing: they are often cited as a contributory cause of excess debts and asset price bubbles.

9. The next problem is that both the above “stockbroker and mutual fund” point and the latter “ICB / boosts the economy” point can be extended to yet further sectors of the economy. For example, taxpayer backed insurance for ships would probably be popular: if you’re a shipowner, being insured by an insurance company that cannot possibly fail has distinct attractions. So such insurance would “boost” the shipping industry and hence the economy as a whole, if the ICB argument is valid.

10. This is clearly getting silly: i.e. what is needed here is some form  of natural dividing line between valid forms of state interference or assistance for banking, shipping and so on, and on the other hand, INVALID  forms of assistance.

11. Well there is actually a natural dividing line which is that it is widely accepted that it is not the job of taxpayers or governments to back COMMERCIAL activity, unless there are obvious reasons for doing so, e.g. social reasons. (I actually argue that point in more detail in an article entitled “A New Justification for Full Reserve Banking”).

To illustrate, long ago in Europe, education and health care were commercial activities: people had to pay for tutors and medical treatment. It was then decided that for social reasons, governments should take over much of that work. But that sort of social reason hardly applies to money lending, i.e. banking, or shipping.

12. Now anyone who deposits money at a bank with a view to having their money loaned out so as to earn interest is clearly into commerce just as much as where they deposit money with a stockbroker with the same aim in view.

In contrast, there is a clear social case for everyone having a totally safe method of storing and transferring money where their motives are not commercial, i.e. where they do not aim to have their money loaned out. Indeed the latter “totally safe” facility is a basic human right.


The advocates of full reserve banking are right: the bank system should offer totally safe accounts for those who want them, while those who want their money loaned out so as to earn interest should bear relevant risks, just as they do when they deposit money with a stockbroker or unit trust.

And of course a consequence of that arrangement is that it is impossible for banks to fail: that is, if a bank makes silly loans, all that happens is that the value of the above mentioned shares / equity falls in value.

Saturday, 22 December 2018

Should banks take climate risks into account?

The latest article (at the time of writing) from the New Economics Foundation is “Greening the Banks” by Frank Van Lerven.

The article claims “Climate change has the potential to wipe out trillions of pounds worth of assets, making the devastation of the 2008 Global Financial Crisis seem like a walk in the park.” That is followed a few sentences later by “This poses severe financial risks…”.

Er  - no I don’t think it does. Reason is that climate change is coming sufficiently slowly that no bank is likely to be caught out by those risks. To illustrate, central London may well be flooded and have to be evacuated at some point, and clearly that will involve a huge loss in the value of assets which back bank loans, e.g. houses and office blocks. But that flooding, according to climate scientists, will not happen SUDDENLY: e.g. by this time next year. It will take around fifty or a hundred years to materialise. 

Of course it could be argued that there are LESS PREDICTABLE risks arising from climate change than the latter flooding. But if the extent of a risk cannot be predicted, it’s a bit difficult, by definition, to quantify it!

The NEF article also considers the loss in value of assets in the form of a contraction of the fossil fuel industry. Well if governments WERE TO significantly contract those industries, and that certainly needs doing, it would be daft to try to do it all in one or two years. I.e. a minimum of about five years would make more sense.

In that case, again, banks have time to adjust.

Penalise dirty lending?

Next, under the heading “Penalise Dirty Lending”, the article proposes extra capital requirements for bank loans which fund CO2 emitting activities. Well the obvious problem there is that extra capital requirements involve little extra expense for banks. Indeed, if the Modigliani Miller theory is right (at least as it applies to banks) there is no extra expense at all!!

Certainly any extra expense via the latter means will be MINUTE compared to the extra expense for motorists that derives from tax on petrol and diesel. Tax accounts for around 65% of the price of petrol and diesel for motorists in the UK at the moment. That dwarfs any extra costs that might be loaded onto “dirty lenders” and CO2 emitters via the capital requirement method.


Something urgently needs to be done about global warming. But there are effective ways to solving that problem and ineffective ways. I prefer the former.