An illogical, self-contradictory aspect of our bank system.

As Edmund Burke said, “Custom reconciles us to everything”. In plain English, it doesn’t matter how raving bonkers some aspect of our economic, social or political system is: as long as that aspect is customary, a large majority of the population will accept it. Cannibalism is accepted in societies where cannibalism is accepted, if you’ll excuse the tautology.

Anyway, and moving on to banks, money market mutual funds (MMMFs) are banks of a sort: like banks, they accept deposits and make loans. During the recent recession, one of America’s MMMFs failed: the “Reserve Primary Fund”. 

Anyone could have predicted that an MMMF would fail at some point and for the following very simple reason. Those funds accept deposits and lend on the money to relatively safe borrowers: i.e. they buy bonds issued by blue chip corporations, cities, etc. But (again, as anyone can tell you) there is no such thing as a totally reliable borrower. That means that at some stage, an organisation lending to those borrowers is absolutely bound to fail.

The reaction of the US authorities was the correct one: they barred MMMFs which lend to anyone more risky than a limited number of sovereign governments from promising depositors that those depositors are guaranteed to get $X back for every $X deposited.

But banks lend to a variety of borrowers who are nowhere near as reliable as blue chip corporations and cities. But banks are allowed to promise borrowers their money is totally safe!!


Raving bonkers, or what?

Of course banks can be made totally safe by having them insured by governments, and indeed that is done via deposit insurance and multi-billion dollar bail outs for banks in trouble.

But by the same token, flouting helth and safety regulations or drinking excess alcohol can be made a relatively safe  in that government insurance could be provided for those flouting those regulations or drinking too much alcohol. That is not a good argument for flouting those regulations or drinking too much alcohol. 


Stimulus.

Another excuse for letting banks promise depositors their money is safe, when it quite obviously isn't (but for deposit insurance etc) is that the effect is stimulatory. I.e. such insurance encourages banks to do more business, lend more etc (i.e. create more debt).

Well one answer to that is the central banks (and governments) can provide any amount of stimulus anytime by creating and spending money into the economy. Moreover, that form of stimulus involves no sort of risk of bank failures, followed by ten year long recessions. Lending by commercial banks certainly serves a purpose, but there is no reason for artificially encouraging it, and hence artificially inflating the total amount of debt.

Second, the above “stimulus” argument applies to MMMFs just as much as it does to banks. That is, promising those who deposit at less than totally safe MMMFs that their money is totally safe would encourage people to deposit at those institutions, which in turn would make it easier for blue chip corporations, cities, etc to borrow! Think of the economic benefits (I don’t think).

But why not take it a stage further and have government organised insurance against loss for those investing on the stock exchange or government organised and taxpayer backed insurance for ships? Think of the economic benefits….:-)

Curiously, most of those who complain about excessive amounts of debt also back the existing bank system which, as explained above, results in an artificially high level of indebtedness.

Cannibalism or the existing bank system seem wholly logical and reasonable once you’re used to them.

In contrast to the existing bank system, there is full reserve banking. Under full reserve, the above mentioned rules that now apply to MMMFs (unless banksters have managed to get the new MMMF rules rolled back) are applied in a wholly consistent manner. That is, no organisation is allowed to accept deposits (i.e. promise those placing money with such organisations that their money is totally safe) if such money is not in fact totally safe.