Why do we subsidise private banks?

Opponents of the TBTF subsidy have missed an elephant in the room: i.e. there’s another large subsidy that private banks enjoy, as follows.

Private banks print and lend out money, as the opening sentence of this Bank of England article explains. But printing and lending out money is inflationary, if the economy is already at capacity (i.e. full employment). So how do governments control that inflation? Well they impose some sort of deflationary measure, like increased taxes, so as to counteract the inflation. But that amounts to a subsidy for private money printers, paid for by taxpayers: in much the same way as the profits made by backstreet counterfeiters are paid for by taxpayer / citizens.

 
A hypothetical economy.

Let’s illustrate that process by considering a barter economy which converts to a money economy.

A barter economy considering that switch can use publicly created money or privately created money. Now privately created money is inherently expensive: private banks have to check up on the credit worthiness of anyone they supply money to. But that expense is not needed where the state simply prints money and spends it into the economy in whatever amounts are needed to bring full employment. So publicly created money is clearly the best choice.

And having done that, no doubt interest rates would settle down to some sort of genuine or optimum free market rate.

But having set up a publicly created money system, private banks in our hypothetical economy would be gagging to get in on the money printing process, just as they do in the real world. Should that be allowed? Well our hypothetical economy COULD ALLOW THAT. And the reason why that would be profitable for private banks is that they can undercut the going rate of interest. Reason is that unlike a normal saver who abstains from consumption and saves and then lends out money, private banks do not need to save: they just print and lend! Nice work if you can get it!


Huber and Robertson.

Joseph Huber and James Robertson described the latter process in their work “Creating New Money”. As they put it, “Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0% debit-interest = 9% profit = 5% normal profit plus 4% additional special profit. This additional special profit is hidden from bank customers and the public, partly because most people do not know how the system works, and partly because bank balance sheets do not show that some of their loan funding comes from money the banks have created for the purpose and some from already existing money which they have had to borrow at interest.”

Now assuming our hypothetical economy is at capacity, government would have to counteract the inflationary effect of that private money printing, e.g. by raising taxes (i.e. robbing various households and firms) so as to enable private money printing. In short, the private sector in general, or parts of it, would be subsidising private money printing.

Put that the other way round, if we stopped private banks printing money (which is what is involved in full reserve banking), the effect of that would be deflationary, which would mean government would have to compensate with some sort of stimulus, like printing more public money (i.e base money) and spending it into the economy. I.e. if in the real world private banks are barred from printing money, then sundry households and firms who were robbed in order to make private money printing get their money back.

You might be tempted to answer that by saying that the latter amounts to helicoptering and helicoptering is not the only possible form of stimulus. Actually traditional fiscal and monetary stimulus comes to much the same as helicoptering. That is, traditional fiscal stimulus consists of “government borrows and spends”. While monetary stimulus consists of “central bank prints money and buys back the bonds that government has issued to the private sector”. That all nets out to “the state prints money and spends it into the economy”.


Banks pay interest to depositors.

You might also be tempted to claim that private banks do in fact pay interest to depositors in respect of the money they print and lend out because the money they print is inevitably deposited at some bank, where the depositor earns some interest. Or at the very least, the cost of running instant access accounts is cross subsidised by interest that a bank earns when it lends out the money in those accounts.

The answer to that is that private banks do indeed pay interest to depositors (if only in the form of charging less than they might otherwise charge for instant access accounts). But that’s simply an example of a well-known phenomenon, namely that when a new line of business opens up, firms which INITIALLY enter the business make substantial profits, while over time, competitive forces cut those profits to something nearer a standard return on capital. I.e. Huber and Robertson’s above example is an over-simplified illustration.

But the question remains: should private banks even be making a standard return on capital out of “printing money and lending it out”? I suggest not, because that business is subsidised for reasons set out above.