Bank lending should be determined by market forces, shouldn’t it?

Pay attention girls and boys and answer the following very simple questions. It shouldn’t be necessary to even ask these questions, but apparently it is.

What’s the best way of determining the optimum number of apples to produce? Well the answer is just to leave it to supply and demand: leave it to the free market - unless there is good reason for thinking the market has got it seriously wrong.

Next question: what’s the best way of determining the optimum number of brass bolts to produce? Answer is the same as above, isn’t it?

Next question: what’s the best way of determining the optimum amount of lending by banks? The answer is as above isn’t it? I.e. leave it to the market – in particular DON’T INTERFERE with the market with artificial subsidies for banks. For example DON’T OFFER taxpayer funded backing for depositors. There is no reason why taxpayers should subsidise banks or depositors.

But that raises a question: aren’t people entitled to a 100% safe way of lodging their money? The answer is “yes”, as long as that “way” is not SUBSIDISED.

And how can we do that? Well it’s easy: stipulate that those who want 100% safety must lodge their money in a 100% safe manner. By all means offer a taxpayer funded guarantee for ultra-safe methods of lodging money, but since the latter methods of lodging money are 100% safe anyway, there is precious little taxpayer exposure there – i.e. precious little subsidy.

Put another way, if depositors want their bank to lend on or invest their money, i.e. take risks with their money, then fine. But there is no obligation on taxpayers to stand behind that sort of commercial activity.

But that raises another apparent problem, which is that under the latter system, a significant proportion of depositors would flee to safety: i.e. forbid their bank to lend on their money, and instead, lodge the money in a 100% safe manner. Shock horror: banks would lend less.

Well there are two answers that. First, the above flight to safety would have a deflationary effect. So government would need to counter that by printing and spending new money into the economy (monetary base). One result of that is the debtors stock of cash would rise, so they WOULDN’T NEED to borrow so much.

Second, I don’t give a monkey’s whatsit if total lending does decline. As pointed out above, the way to determine the optimum amount of lending is supply and demand: i.e. absent any reason for thinking the market has gone seriously wrong, the optimum amount of lending is determined by the free market: that’s a system that involves NO SUBSIDIES.

But if you think that the sort of excessive and irresponsible lending that took place before the crunch was OK (think Spanish and Irish property development), then I suggest you’ve lost the plot.