27 November 2010

Beginning of a Monetary Revolution?

Reposted in full from new economics foundation, 14 November 2010

'"The essence of the contemporary monetary system is creation of money, out of nothing, by private banks often foolish lending."

These are the words, not of a monetary crank, but of The Financial Times' Chief Economics Commentator, a member of the national Independent Commission on Banking (ICB), and probably the most decorated and prestigious economics journalist in the country. Martin Wolf wrote them in an article last week defending the Federal Reserve's right to embark on a second round of Quantitative Easing. He went on to say: "Why is privatisation of a public function right and proper, but action by the central bank, to meet pressing public need, a road to catastrophe?"

Quite so Martin. The truth is, as was explained at a conference in central London this weekend organised by Positive Money in collaboration with nef, that banks are no longer just intermediaries of our money. Rather, they are the creators of our money. Most estimates suggest that between 97-99% of the money in our economy is created as interest-bearing debt by banks when they make loans to us, the rest being cash. These loans are made, quite literally, but typing some numbers in to a computer and creating a liability for you, the borrower and an asset for the bank. It costs them nothing. There are complex rules - the Basel Framework - requiring banks to hold a very tiny amount of capital reserves in case of a 'run' - but essentially this is how fractional reserve banking works today.

Or rather, doesn't work. Because these same banks that can issue credit out of nothing for whatever they want (and make money out of it and whose shareholders have limited liability) also hold on to our hard-earned savings. If they just so happen to make some bad investments and get 'over-leveraged', our savings can go too. Unless the state jumps in of course. Which as we have seen, it has had to at a crippling expense to each and every one of us. But there's no need for radical think tanks like nef to make this point any more. We can just quote the Governor of the Bank of England, Mervyn King, who pronounced in a speech on October 25th that:

“Eliminating fractional reserve banking explicitly recognises that the pretence that risk-free deposits can be supported by risky assets is alchemy. If there is a need for genuinely safe deposits the only way they can be provided, while ensuring costs and benefits are fully aligned, is to insist such deposits do not coexist with risky assets.”

The speakers at this weekend's conference were revealing. They included a Conservative MP, Steve Baker, the Director of a company who distributes fish and meat to 6800 retailers, a former stock-broker and banker, an eco-feminist academic as well as nef and Positive Money, both NGOs. In the audience trade unionists bumped up against city traders and young students schooled in orthodox economics cheered as they heard how most of what they had been taught was nonsense.

Left and Right appeared to be in substantive agreement over the problem. The monetary and banking system as it stand breaks all the rules of the free market and at the same time utterly fails to deliver socially just and ecologically sustainable outcomes. The alternatives will no doubt be discussed and argued over for some years to come. But it appears that a monetary revolution has just begun. As King went on to admit in his speech:

"Of all the many ways of organising banking, the worst is the one we have today."'

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