Sunday, 4 October 2009

Banks aren't lending - so what?

Why on earth do governments, having prevented a total collapse of the bank system, want to rely on bank lending to stimulate our economies?

The basic purpose of preventing a collapse of the commercial bank system was to prevent a collapse of the money transmission system (an essential “utility” service, much like electricity or water distribution). That is, the basic purpose was to make sure wage and salary payments, for example, continued to be made, and to make sure household savings accounts did not disappear into thin air.

But there is no need to give the idiots and fraudsters running large banks more than is needed to enable them to continue this basic service. Give them more than this, and they’ll probably just revert to what they’ve been doing for several decades: throwing billions down the drain, if no trillions. The “Savings and Loan” fiasco of the 1980s and 90s cost the US taxpayer over $100bn. The large US banks were essentially bankrupted by the 1980s Latin American debt crisis (see 5th October post at "Washington's Blog"). And now the 2007-9 credit crunch has knocked how much of world economic output: 5%? That is more trillions gone west.

Having given the above bare essential stimulus to banks, all further stimulus should be channelled to the source of all demand. Which is? . . . . .the consumer! Some of us were saying this a year ago: e.g. me, Winterspeak, the IMF (p.6, section 16), Simon Jenkins, James Surowiki, etc.

But senior politicians in charge of large government departments probably think that no one can do anything unless they are (like themselves) in charge of something big (like a government department or a large bank). Well senior politicians need to understand that the average convenience store owner has just as much business sense than the average finance minister.

And the evidence supports this, in a way. That is, small banks have done relatively well during the credit crunch. And in Europe, some firms (with no experience whatsoever of banking, but with cash to spare) have in 2009 increased the extent to which they play the part of banks, for example lending to other firms which they know to be sound businesses.

In a free market, the most efficient should be allowed to expand and on occasions drive the less efficient out of business. If an engineering firm in Detroit is a better judge of the creditworthiness of other engineering firms in Detroit than banks, then banks should under no circumstances get preferential access to taxpayers’ money designed to encourage loans to firms in Detroit.

Another reason politicians may have preferred to give money to millionaire bankers rather than to the peasantry is that what might be called the “informal” banking system that “peasants” would come up with, given half a chance, would probably require a bigger monetary base than the existing “big commercial bank” system. This is because the large commercial bank system can effectively print money. That is, it can build a very large “pyramid of credit” or “pyramid of printed money” on a relatively small monetary base.

Engineering firms in Detroit cannot do this. But this is no reason not to allow engineering firms in Detroit to play the part of banks. Creating monetary base does not cost anything in real terms. Also, while increasing the monetary base may be inflationary OTHER THINGS BEING EQUAL, the effect will not be inflationary where the monetary base is increased because engineering firms in Detroit genuinely NEED that monetary base to engage in banking activities. In short, politicians may be reluctant to allow engineering firms to play the part of banks because politicians fear that the increased monetary base needed will be inflationary. These politicians are wrong.

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