Sunday, 20 July 2014
Jem Bendell says Bitcoin type systems can replace conventional banking.
Obviously there is a market for Bitcoin type systems, but the idea that they can replace the bulk of what conventional banks can do is unrealistic, I think.
The first big problem with Bitcoin in particular (though not necessarily with all Bitcoin type systems) is that Bitcoin gyrates in value.
Now the biggest category of loan organised by conventional banks is mortgages. And if you want to borrow say £50k for ten years, are you really likely to be happy with the loan being denominated in Bitcoins which gyrate in value? It’s possible given the limited number of Bitcoins that will be issued that their value will treble over the next ten years. Who wants to see the REAL VALUE of their debt treble? About 1% of mortgagors might want to expose themselves to that sort of risk, i.e. I suggest that about 99% won’t.
As for those doing the lending, same applies. People who currently have a few thousand to spare for a few years and which they currently place in a conventional bank are not the sort of people who want to take the risk of seeing their savings halve or double in value. If they were, they’d buy stock exchange quoted shares or something of the sort.
Next, as Jem puts it, Bitcoin type systems involve “members of a network trusting each other rather than a bank.” Well now that’s fine for relatively small scale transactions: if the person you trust turns out to be dishonest you won’t lose too much.
But people who place significant sums in banks are not prepared to see the bank grant mortgages simply on the basis of “trust”. Any bank or Bitcoin type system that granted mortgages simply on the basis of trust would inevitably grant a fair number of NINJA mortgages, and that just leads to insolvency. Rather, those placing their savings with banks want to see the bank grant mortgages only in exchange for decent collateral from mortgagors, normally the title dees to a house. And that’s what conventional banks do.
Loans to businesses.
Much the same applies to loans to businesses. Those placing money in conventional banks do not want to see their money being loaned to businesses simply on the basis of “trust”. They want to see the bank give prospective borrowers a good grilling, including (quite rightly) examining cash flow projections, etc. And if the business can’t give the bank collateral in exchange for the loan, then those placing money in the bank will want to see the bank charge a correspondingly higher rate of interest.
Conventional banks don’t always charge interest.
Jem then claims an advantage of Bitcoin systems is that “This is “collaborative credit” as it involves members of a network trusting each other rather than a bank. Collaborative credit doesn’t come with interest demands…”. And “About 97% of money we use is created by private bank lending, which comes with interest.”
Well actually conventional banks, contrary to popular perception, do not charge interest when they create what might be called “genuine transaction money” – as opposed to organising long term loans. I’ll explain.
Assume an economy where people want a form of money with which to trade, but they don’t want long term loans. Banks would credit everyone’s account with a stock of money (probably in exchange for collateral).
Now while banks would charge for ADMINISTRATON COSTS involved there, there is no reason to charge genuine interest. Reason is that interest is a charge made for the inconvenience or pain involved in abstaining from consumption so that someone else (the borrower) CAN CONSUME. And when a bank simply credits your account, neither the bank itself, nor its shareholders or employees “abstain from consumption” in any conceivable way. And as to households and other non-bank entities in our hypothetical economy, they don’t do much “abstention” either, and for the following reasons.
When household X or person X buys stuff from Y, obviously X is temporarily in debt to Y and Y might demand interest, which the bank would have to charge to X. But normal practice in the real world when a firm supplies goods to another is to allow one month’s grace before interest is demanded. And indeed a one month period of grace is allowed with most credit cards. So let’s assume that one month “zero interest” policy applies in our hypothetical economy.
Moreover, given that everyone is trading with everyone else (which is more or less what happens in the real world), each person’s bank balance would rise ABOVE the above mentioned “stock of money” originally credited to their account as often as it fell BELOW that original stock or balance. Indeed, given the one month period of grace mentioned above, bank balances would tend not to stay above or below their original level more than a month.
In that scenario the charging of interest of interest would not occur: it would be a waste of time. Ergo in that scenario banks would not charge GENUINE interest. Doubtless they’d charge for administration costs, but they would not charge genuine interest. Incidentally I enlarged on the above point here a month or two ago.
The “trust” element that is involved in Bitcoin type systems gives them the edge over conventional banks when it comes to DAY TO DAY TRANSACTION MONEY. But the trust element is not a big advantage otherwise. “Trust”, is fine for small scale transactions, but not for the bulk of the loans organised by conventional banks: mortgages and loans to businesses.
Second, the idea that Bitcoin type systems absolve those concerned from interest is not strictly true because conventional banks do not charge interest in that they simply create transaction money (as opposed to long term loans) for all and sundry. Conventional banks however DO CHARGE for the administration costs involved in the creation day to day transaction money, and if Bitcoin systems can avoid those administration costs, then they’ve got the edge on conventional banks when it comes to day to day transaction money.