Tuesday, 15 May 2012

Banks are inherently fraudulent institutions.

A bank, by definition, is an institution which undertakes to return $100 to depositors for every $100 deposited. Or to be strictly accurate, it undertakes to return $100 possibly plus some interest and possibly less some expenses. However the two latter are small compared to the capital sum: about 5% of the capital sum per year at most.

In contrast to guaranteeing to return $100 for every $100 deposited, investment and lending are risky activities. If you “invest” in the stock exchange, or in your own business or the business of a friend or relative, you might double your money or lose the lot.

Thus the phrase “investment banking” is blatant self-contradiction: it’s fraudulent. Or rather it’s an attempt to fool depositors: it’s an attempt to persuade them they can be guaranteed to have their $100 back, at the same time as reaping the rewards of engaging in commerce: making an investment that might involve the $100 disappearing. And normal banking or retail banking isn’t much better.

And who pays for the above fraud or charade? Well, it’s the taxpayer.

Unit trusts and mutual funds don’t make the above absurd promise about returning $100 per $100 deposited, so why should banks be allowed to make this promise?

Fooling politicians and everyone else.

The word bank, and in particular the phrase “investment bank”, are also attempts to fool politicians. Those are the folk who are supposedly the guardians of taxpayers’ money, but who in fact are easily fooled into parting with taxpayers’ money.

That is, ever since banks first appeared on planet Earth, bankers have persuaded politicians that the banking system cannot be allowed to fail, thus taxpayers’ money must stand behind banks, including investment banks.

Ban bank lending?

So the logical course of action would seem to be to certainly ban banks from investing, but also to ban them from lending. However there is an apparent problem there, or rather there is an alleged problem which most bankers know perfectly well is not a problem at all. It’s a pseudo problem which politicians can easily be made to fall for. And it’s the alleged fact that if banks don’t lend, that constrains economic activity. Or it constrains growth. And banks are very concerned about growth: you can tell that from the fact that they’ve done about as much for growth over the last five years as was done for the economic growth of Hiroshima and Nagasaki by the atomic weapons dropped there.

Now obviously, all else equal, if banks stop lending, that constrains economic activity. That is, if those with money to spare cannot invest their money via one of those fraudulent institutions we call “banks”, then less investment or lending takes place. (Those with money to spare can still of course invest via other entities: the stock exchange, unit trusts, mutual funds, etc).

But the above assumption that all else needs to be equal is of course total nonsense. That is, the deflationary effect of preventing banks from investing or lending can easily be compensated for by increasing the money supply.

Those Austrians, yawn, yawn.

Now the knee jerk reaction of Austrians and other simpletons to the phrase “increase the money supply” is entirely predictable: they’ll start chanting “Weimar”, “Mugabwe”, “inflation”, etc. However (to repeat the point for the benefit of simpletons) the above money supply increase won’t be inflationary as along as the stimulatory / inflationary effect equals the DEFLATIONARY effect of stopping banks engaging in investing or lending.

Another factor that contributes to the reluctance to constrain, if not ban bank lending is the popular perception that money in a bank somehow represents real wealth; and that failure to invest this money means real wealth lying idle. Most politicians suffer from this delusion, and even those sitting on Britain’s recent investigation into banking, the Vickers commission, suffered from the delusion.

The truth is that money in banks is nothing more than a series of book keeping entries (or if you like, numbers in computers). Money is nothing more than a claim to resources. It is not “resources” as such. It does not equal real investment in the same sense as a house or factory is a real investment.

Back where we started?

Now it might seem that if we ban investment and/or lending by banks and compensate for that by increasing the money supply, that we’re back where we started.

Well we certainly OUGHT to be back where we started in that GDP would be back to where it started. But we wouldn’t be back where we started in a very important sense: taxpayers would no longer be underwriting commercial activity. That is, taxpayers would no longer stand behind investments or loans made by banks.

In fact, if the cross subsidisation of banks and depositors by taxpayers is banned, then GDP ought to RISE, all else equal.

Taxpayers SHOULD stand behind genuine savings accounts.

In contrast to investing, having access to an account which is 100% safe is arguably a basic human right. Possibly this sort of account should be run by the state. Or possibly banks should be allowed to run this type of account, with state backing, but with very strict limits on what can be done with the money.

Even investing in government stock is questionable because such stock can rise or fall in value. Personally I’d allow nothing to be done with the money other than lodging it at the central bank.

Basle plonkers.

Of course an alternative way to ensure bank safety is to ensure adequate bank capital. That supposedly means that when a bank has an unusual run of bad luck or incompetence with its investments or loans, depositors’ money is still safe.
But the problem there is the people framing rules on capital adequacy are manifestly incompetent, plus they are wide open to regulatory capture. According to Mervyn King, the best capitalised bank in the UK according to Basle II rules three months before the collapse of Northern Rock was . . . . have a guess . . . . wait for it . . . Northern Rock.


The best solution is just to ban institutions which promise to repay $100 for every $100 deposited from investing or lending.



  1. Hmmm, my reaction to 'increase the money supply' was actually, how are you going to do that now that you've essentially eliminated most of the usual monetary policy transmission mechanisms? It would require a wholesale change in the way central banks operate.

    1. People would still be able to put their money into institutions that provide mortgages or that lend to, or invest in businesses. So expanding the money supply would tend to increase the money available for mortgages, investment, etc. I’m just suggesting that any institution that provided mortgages or made investments should not be called a bank, and should not be allowed to promise to return $100 to depositors per $100 deposited.

      Plus all literature issued by such institutions should state in bold font that depositors are not guaranteed their money back.

      I’m actually advocating the same as the two account system set out on p.7 & 8 of this submission to the Vickers commission - except that that submission does the split between 100% safe accounts and what they call “investment” accounts WITHIN each bank:



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