The public is mad with the bankers, and it should be. It has every right to be. But the public should be equally mad with the state and the politicians, maybe more so. In any case, these two groups are in cahoots, and the rest of us pay the price. This price comes in the form of distorted markets, artificial booms with severe busts attached to them, mountains of debt and rising inflation. The state-bank alliance is the very antithesis to capitalism and free markets. And state and banks are eager to sustain it.
Let us take examples from last week’s media reports. The rating agency Moody’s publicly disagreed with the Bank of Spain in its assessment of the capital requirements of Spanish banks. The former thinks the banks are in need of more capital than the latter does. Then there were allegations – most certainly correct – that the German government watered down ‘stress tests’ for banks out of concern for their own heavily protected banking industry.
What is it with these stress tests, anyway? In a market economy there is only one stress test, and that is the market. For the last three years, the state has done everything it could (and more) to protect the banks from market forces, and now we are to believe that the banks are ‘stress-tested’ in state-protected captivity before they are released back into the wilderness of the capitalist jungle? I cannot believe that anybody takes this seriously. Does anybody really believe that politicians and state bureaucrats can and should be the judges of what business will survive in the free market, or that they even have tools and mechanisms to predict the particular stresses that the markets will bring about?
‘Industrial policy’ has rightly been condemned for being based on the silly notion that state officials could pick winners. In the case of banking the situation is even more ridiculous, because here, everybody is a winner. Or at least, nobody is a loser. Just look at Northern Rock which now runs radio ads for its mortgage business again.
In banking, failure really is not an option. Everybody survives, courtesy of the state. “No banker left behind”. And in a business in which you cannot go under, at least if you are of a certain size, you can make a lot of money. Just ask Bob Diamond.
Of course, people like Mr. Diamond never forget to remind us that their institutions – in his case Barclays of the UK – didn’t take any taxpayer money and were not bailed out. This is supposed to make us believe that these firms are entirely free market enterprises, equally at risk of bankruptcy as the restaurant around the corner or the newsstand down the street. Truth is, in a paper money economy banks are never free market enterprises. They simply cannot be capitalistic corporations.
All banks presently benefit from state support, even those that do not receive funds taken from the taxpayer. All banks benefit from the very low refinancing rates that the central banks have set specifically to help the banks. We are constantly told that these stimulating rates are in everybody’s interest but they hurt the savers – the people who are certainly not to blame for the crisis and who are now repaid for their prudence and restraint by not receiving much interest income on their bank deposits and by suffering rising inflation at the same time.
Then there are the various programs of debt monetization, most of them still continuing and certain to increase in scope over time. Central banks around the world, including most importantly the U.S. Federal Reserve and the ECB, have offered their balance sheets as dumping grounds for the unwanted and unsalable junk that the banks have, at handsome fees, accumulated during the lending spree. The Fed bought about $1trillion of mortgage-backed securities from the banks and gave them freshly printed cash in return. To this day, the ECB is keeping hundreds of banks alive by funding, at very favorable rates, the worthless trash that piled up on their balance sheets. Thus, trillions of assets around the world are still not being priced according to true private demand for them. Hundreds of billions of losses are being concealed this way by the central banks and also by the governments in an effort to mask the damage from the credit boom and to socialize its costs. Monetary and fiscal policy is engaged in a cynical game of cover-up and make-belief.
I know, I know, many ‘responsible’ readers will now say that the politicians had no choice. If they hadn’t done what they did we would have another Great Depression. But we are getting a depression anyway, and the longer this shameless farce continues, the worse it will get. None of this solves the real problems.
Why does the state go to such lengths to protect the bankers? Because the state is as hooked on cheap credit as an Irish real estate agent. Well, let’s look at the stress tests again: Revealingly, in the 2010 version of the European ‘stress test’ that 84 of 91 institutions passed, including two by now defunct Irish banks, the state excluded its own obligations from the stress tests. Government bonds that the banks buy and intend to hold to maturity are considered ‘safe’ assets. Of course, the very notion of ‘safe’ assets is ridiculous in a free market. It doesn’t exist in the complex world of uncertainty that you and I inhibit. But we are made to believe it can exist in state-managed capitalism. The state bureaucrats who supervise and ‘stress-test’ the banks are making lending to the governments ‘stress-free’ for the bankers at a time when more and more states are locked in a veritable debt-death spiral. Deficits and public debt loads are ballooning everywhere, and European governments already had to be bailed out by their neighbor states.
Why were they bailed-out? No prize for getting the answer: not to save the euro, which is an irredeemable piece of paper and therefore unaffected by any of the sovereign states repaying only part of their outstanding debt, but to blatantly help the banks that are lending generously to the various governments, and that the states want to keep lending. If Germany and France and the UK had Greece and Ireland go bankrupt it would have caused considerable pain for their respective banking industries. It would have meant less available credit and higher borrowing costs for all other sovereigns. All states still benefit from the myth that states don’t go bust. They want to keep it that way as they all depend on cheap credit. (Of course, all of these defaults are still to come. But that is a different story).
So now a clearer picture emerges: The state encourages the banks to lend and bails them out when credit boom turns into credit bust. The state then publicly blames everything on the greedy bankers and promises to sort them out, not by letting them go under as would befit a proper market economy, because this would cut off the state from fresh credit supply, but by having them undergo some stress test from which lending to the state is conveniently excluded. Additionally, states that borrowed too much during the credit boom get support from other states but under the condition that they then heavily tax their private sectors and fully repay the bankers and bond investors, on whose ongoing generosity all other states depend. “Hey, don’t mess with my bond investor!”
The symbiosis between states and banks is an integral part of a system of state paper money. Historically, all paper money systems were introduced with one objective: to fund the government. None of these systems survived. At some stage the state always issued too much paper money, and after a devastating crisis, society returned to the money of the free market: gold or silver.
In our system, there is an additional objective: to allow large-scale credit creation on the basis of money creation rather than saving. Our system is designed to support fractional-reserve banking.
Today all banks are fractional-reserve banks. They lend money by creating money. Whenever you put your physical money into a bank account – whether it is the gold coins of yesteryear, or state paper money today – the bank calls it a deposit, and you consider yourself still the owner of that money. But in fact, you exchanged money for a claim against the bank. The bank doesn’t keep your money but lends most of it to somebody else who now also considers himself the owner of that money. As few people ever take out loans to sit on the cash, it is most likely that the borrower will spend the money. The receiver of that money deposits it with another bank, and so the process starts all over again.
Through this process the banks create bank deposits that the public considers a form of money because they are supposed to be instantly convertible into the state’s paper money. But the banks hold reserves for only a fraction of these deposits. This process allows the banks to augment their lending through money creation. By lowering their ratio of reserves to deposits, the banks can lend more money than has ever been designated by any of their customers for proper lending activity.
Obviously, this process is dangerous for the banks. Making uncovered promises gets you into trouble sooner or later. Fractional-reserve banking is the reason bank runs occur. Less obviously but no less problematically, this process also destabilizes the broader economy as it allows credit-funded investment to exceed voluntary saving. Fractional-reserve banking is at the heart of the credit-driven business cycle.
Under a proper gold standard, fractional-reserve banking is naturally limited. Money proper is gold, and therefore bank reserves are gold. Nobody can quickly and by administrative decision expand the supply of gold. Banks have to be very careful not to lower their reserve ratios too much, and depositors will be concerned about banks that lend too generously.
I am not in favor of outlawing fractional-reserve banking. As a zero-state libertarian I agree with P.J. O’Rourke: “There is only one basic human right, the right to do as you damn well please. And with it comes the only basic human duty, the duty to take the consequences.”
But only in a hard money system do the banks, their customers and shareholders take the consequences. In the soft money system of limitless paper money from the lender-of-last-resort central bank, banks are constantly bailed out with freshly printed new reserves and encouraged to lend more and more. The consequences are socialized through ongoing inflation and increasing economic imbalances.
Since April 1933, when President Roosevelt took the dollar off gold domestically and confiscated all privately held gold by executive order, the Fed has increased the monetary base and bank reserves by a factor of more than 320. Just last month, the Fed added $167 billion dollars to bank reserves. That is more money in one month than Paul Volcker created in eight years as Fed chairman. As the dislocations from the paper money inflation mount, bank reserves have to grow ever faster to keep the ‘cheap credit show’ on the road.
The credit cycle is greatly amplified in this system of ever-expanding paper money. We had an almost thirty year boom. It ended in 2007. State and banks desperately want to resurrect it. Consider the public display of their antagonism as a staged show. It is purely for the gallery. Their interests are closely aligned. One thing, however, has to give, and that is the purchasing power of the paper money.
I have some respect for Mervin King, the governor of the Bank of England, who strikes me as a deeper thinker than the conceited Ben Bernanke. Last week Mr. King had a pop at the bankers and he asked the state authorities to get tough on them, potentially to even break up the big banks and to allow their failure in future crises. He is barking up the wrong tree.
The whole purpose of the paper money system is to allow ongoing credit growth by money creation. On the moist and soft surface of limitless paper money, a highly leveraged financial industry and a highly indebted public sector grow like fungi. Only the introduction of hard money, of apolitical commodity money, would put an end to this system. Neither the state nor the banks have any interest in it. The central banks will be forced to keep underwriting both, the leveraged and now re-leveraging financial sector, and the ever more indebted state. This must lead, at some point, to hyperinflation. Paper money collapse. You know that I think we are not far away from that point.