Friday, 1 May 2015

Private money printers cannot survive without taxpayer backing, so let’s ban them.

Commercial banks create or “print” money when they grant loans, as the opening sentences of this Bank of England publication explain.

However, there is no excuse for taxpayer funded subsidies or backing for private banks. But if all such backing is removed, then bank funders (especially depositors and bond holders) by definition become shareholders. At least they become shareholders as in “someone who at worst stands to lose everything”.

Of course depositors and bond holders (henceforth “debt holders”) are not EXACTLY the same as shareholders. But that’s not too important. The IMPORTANT point is that exposure to risk as a result of withdrawing taxpayer support for banks means that debt holders will demand a similar return on their stakes in banks to the return demanded by shareholders.

To be more accurate, those debt holders will demand a return approximately equal to the return demanded by PREFERENCE shareholders. The EXACT definition of a preference share varies from corporation to corporation, but roughly speaking, a preference shareholder is one who does not take a hair cut till ordinary shareholders have been wiped out. And exactly the same applies to the above debt holders: they don’t take a hair cut till after ordinary shareholders have been wiped out.

In short, there is no difference between funding a bank JUST VIA equity, and funding a bank partially via equity and partially via so called debt – which is perhaps more accurately described as preference shares.

So far, privately created and publicly created money are running neck and neck. However there  MAJOR flaws with privately printed money. The first is that large chunks of it can vanish in a puff of smoke when a bank goes bust. Indeed in the 1930s (before the days of deposit insurance) around six billion dollars of households’ savings or “money” was wiped out in the US. And I’ve no idea what six billion is in today’s money, but it’s certainly “lots”: maybe a trillion.

Apart from the blatant injustice there, there is also the fact that bank runs, credit crunches and so on are VERY DAMAGING. We’re only just recovering from one such episode stemming from about seven years ago.

The cost of privately and publicly printed money.

A second drawback of privately created money is that it costs more to create than publicaly created money (aka base money). Reason is that before granting a loan, a private bank normally has to check up on the value of collateral offered by the borrower, and the cost of doing that in the case of the single biggest form of borrowing, i.e. mortgages, is several hundred pounds per mortgage.

A tempting objection to the above point is that if privately created money is inherently expensive, why does it manage to compete with base money? The answer is that money creation, i.e. seigniorage, is profitable, and if the profits from seigniorage more than cover the cost of checking up on the value of collateral, then private money creators are onto a good thing.

Deposit insurance.

Another possible objection to the above arguments is that the problem of privately created money vanishing in a puff of smoke is easily dealt with via deposit insurance. The answer to that is that deposit insurance does not make sense, and for reasons I set out here.


Private money printers are just a nuisance. Money creation should be the sole preserve of the state.

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