Monday, 9 February 2015

Is more lending / debt desirable or not?

The great and the good – aka the dozy elite - spend a significant amount of time deploring the rise in household and other debts over the last decade or so. But in the next breath they often warn that excessive bank regulation will cut bank loans and hence economic growth. So do they want more lending / debt or less?

One of the worst offenders is Vince Cable, the UK’s so called “business secretary”. For example, according to this Financial Times article he claims (scarcely believable this) that commercial banks shouldn’t be forced to have more capital because  that would allegedly damage economic growth. Well if there’s on thing nearly every economist now agrees on, it’s that banks SHOULD HAVE more capital. Indeed, Martin Wolf, chief economics commentator at the Financial Times argues that banks should have VASTLY MORE capital: much more than advocated by the Basel regulators.

But in contrast, Cable says here, “I am very concerned by the build-up of household debt in relation to income.” And if you want to watch more members of the great and the good brigade hyperventilating about excessive household debts, see here.



Any old fool can take some event or variable, e.g. an interest rate rise, and point to one or two consequences. In contrast, and far more useful is work out the OPTIMUM level of interest rates, debts or any other variable.

So, does Vince Cable and the rest of the UK’s dozy elite think more lending is desirable or not, i.e. what do they think is the OPTIMUM policy here (if they understand the word “optimum”). Before they give us an answer, they should ponder the fact that it’s debatable as to whether increased capital for banks really has any effect on bank funding costs and for the following reason.

According to the Modigliani Miller theory, altering the way a corporation is funded (capital versus debt for example) has NO EFFECT on the cost of funding the corporation. And Messers Modigliani and Miller got Nobel Prizes for their efforts, so they weren’t stupid.

Bank subsidies.

A second and quite separate point here is that even if more capital DOES RAISE bank funding costs, that is not necessarily undesirable and for the following reason. It is widely accepted that all bank subsidies should be removed, though the dozy elite are moving at a snail’s pace in actually putting that into effect. Sweetners paid by banksters to politicians no doubt help ensure the snail’s pace doesn’t speed up. (The financial industry spends £90m a year on lobbying in the UK).

Now if all bank subsidies are removed, then those funding banks OTHER THAN shareholders (i.e. depositors, bond-holders, etc) effectively become shareholders. That’s “shareholder” as in “someone who stands to lose everything in the worst case scenario”. And that’s different to the CURRENT scenario where, at least in the UK, depositors are protected by insurance funded by taxpayers: a blatant subsidy of the bank industry. Clearly the latter depositors do not stand to lose everything. In fact, they don’t stand to lose ANYTHING!!!

Indeed, therein lies another self-contradiction in the brains of the great and the good. That is, ask them if bank subsidies should be removed, and they’ll say “yes”. But ask them if depositors should have to run the risk of losing their deposits and they’ll say “no”.

Of course if the above self-contradictions were put to Vince Cable or any other skilled politician they’d be able talk their way out of the self-contradiction. Doubtless they’d be able to argue that black is white. But those of us with a SERIOUS interest in this subject want to see some sort of OPTIMUM banking system, i.e. a system that gives us the OPTIMUM level of lending and debt. So here’s an idea for achieving that optimum.

Free banking.

It’s widely accepted that the FREE MARKET gives an optimum allocation of resources, bar a number of specific areas where a totally free market does obvious harm: e.g. giving factory owners freedom to pollute their surroundings. And in the case of banks, a free market would involve removing all bank subsidies. Indeed, advocates of so called “free banking”  advocate taking that further and letting private banks issue their own dollar bills, pound notes, etc.

Free banking is OK by me as long as depositors have the option of some sort of totally safe state backed account to lodge their money in. With a view to achieving the latter, William Hummel advocates that everyone should be able to open an account at the central bank. But that’s just one way of doing it. As an alternative, one could have commercial banks act as agents for the central bank.

And what do you know? The latter system, i.e.  totally safe, state run accounts combined with what might be called an “anything goes” private banking system is pretty much what full reserve banking consists of, a system I back. There’s just one constraint that needs to be put on those private banks (and free banking enthusiasts won’t agree with this), and that is to restrict their freedom to issue any sort of liability which is too near to being money. Reason for that is that private banks, as is currently the case, issue most of the country’s money supply, and if a series of such banks collapse, the country’s money supply vanishes or is dramatically reduced. As Irving Fisher put it in the 1930s, “The most outstanding fact of the last depression is the destruction of eight billion dollars-over a third - of our "check-book money"- demand deposits.”

A system under which it is possible for a third of what households and small businesses thought was safe money to disappear is just not acceptable.


The optimum amount of lending and debt would arise where borrowers and lenders are free to come to any mutually acceptable agreement they like: using a bank as an intermediary or not. The main constraints needed are first, private banks’ freedom to portray their liabilities as money should be constrained. Second, to make up for that constraint, the state should make totally safe accounts available to anyone who wants them.

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