One thing that is increasingly obvious is that the current model used by much of the world for managing public monetary systems is fundamentally broken. Instead of serving the public interest modern monetary systems are serving a select few as they are deployed in blowing ever more imaginative asset price bubbles. Understandably many are calling for a return to a Gold Standard to end the “bubble blowing” but is that the best solution to the problem?
About the only good thing that can be said about the mania for deregulating private bank credit creation over the last 30-40 years is that it has made identification of the core sickness of modern western economics much easier.
While bank credit creation was relatively closely regulated to increase the likelihood it was being directed to productive purposes, it was difficult to discern the fundamental defect of effectively privatising the power over the creation of public money. Provided the privatised power was generally being directed to productive purposes most people were happy to let bankers occupy an important role in the public monetary systems of most western countries.
It is important to remember that the specific role played by bankers during the era of closely regulated credit creation (1940 to approx 1980), varied between countries depending on the nature of the credit regulations in force. Those regulations in turn reflected the resource allocation priorities of governments and, to the extent the governments were democratic and reflected the interests of their populations, it could be said that private bank credit creation, when carefully regulated, reflected at least in part the priorities of the general voting population.
However, this ended with the deregulation of private bank credit creation as the whole point of deregulation of private bank credit creation was the theory that the invisible hand of the ‘market’ and profit hungry bankers were the best judge of who should be given private bank credit and for what purposes.
The only limitation on this wonderful ‘freedom’ for bankers was that bank failure was to be avoided, if possible. Thus we saw the rise of new regulators who described themselves as “prudential regulators” rather than regulators of “credit creation” itself. As long as a bank did not go broke it could essentially do whatever it liked in terms of granting credit to those it judged ‘credit worthy’. In Australia the prudential regulator was called the Australian Prudential Regulation Authority (APRA).
The only other control over the credit creation activities of the private banks was to be exercised by the Reserve Bank of Australia who would use a single interest rate, the target or overnight rate, to influence a range of other interest rates and in doing so the demand for various types of bank credit.
To reinforce this religious faith in the wisdom of the invisible hand of the market the regulators of private banks, the RBA and APRA, were given ‘independence’ from the government.
So complete was the victory of the ‘free market’ theories that governments rushed to sell off public banks across the globe so they could benefit from the magical powers of the market and deregulated credit creation.
So how did this experiment go?
Not very well.
The most outstanding feature of the period of deregulated private bank credit has been a series of bubbles in a range of asset prices. Each bubble has been bigger than the last and judging from the explosion of debt, public and private, after the GFC we are currently blowing the mother of all bubbles.
It appears that “free market” theories don’t work so well when it comes to private bank credit creation. The wise all knowing invisible hand of the market has gone missing and instead we find that the hands doing the ‘work’ are attached to some bonus hunting banker or their symbiotic co-life form …the asset price speculator.
So what went wrong?
The problem is very simple.
When a private bank creates credit that can be exchanged by law one for one for credit created by the government you have effectively given banks power to create something very close to public money when they create a bank loan.
You don’t need to be Einstein to work out what happens when you give someone a power to create public money and then deregulate how they use that power.
They start using the power…… a lot. What that means is bankers start creating as much credit as they can find ‘credit worthy’ people willing to sign loan contracts.
In other words what deregulation of private bank credit creation meant was nothing more than money printing on a grand scale by the private banks rather than government. The money printing took the form of private bank credit and it was directed to pumping up asset prices, especially the price of land.
Certainly there were ‘some’ theoretical limits on the money creation by the private banks. No one is suggesting they were given a magic money tree.
Apart from the practical requirements of staying solvent and ensuring they had the means to meet day to day operational requirements, the local prudential authorities and their international counterparts issued all sorts of guidelines about capital adequacy and/or deposits. But these were generally only intended to stop banks blowing themselves up. And as we know from the visible and not so visible local and international bailouts of banking systems, including the Australian banking system, around the western world after the GFC, prudential regulation proved to be a colossal failure.
Not that any of them will admit it of course. They are worried the public might lose ‘confidence’.
What about inflation?
One of the interesting features about the privatisation of the public power over money creation during the era of deregulated private bank credit creation has been the low levels of inflation…or at least one type of inflation.
Even allowing for the fiddling of how CPI inflation is measured to make it appear lower, in general the CPI inflation measures have been low despite the out of control levels of private bank credit creation.
The reason is straightforward when one considers that the money creation by the private banks has been directed to pumping up asset prices of the asset rich rather than putting money in the wallets of the average worker. So while asset owners are getting rich and feeling mighty good about life, most people have not seen much ‘trickle down’ from the bank accounts of the asset rich.
Plus those who have been brave and have jumped on the “ladder of opportunity” and taken on a mountain of debt to acquire a property often find their remaining disposable income is so limited that they have very little power to stimulate demand elsewhere in the economy.
A bit like the poor sailor in the Ancient Mariner, the private banks were creating credit / money everywhere but not much more than a drop for the real economy to drink.
What has this got to do with a gold standard?
In order to assess whether the return to a gold standard will solve a problem we need to be very clear as to what the problem is it is trying to solve.
Keep in mind that one of the features of the era of private bank credit creation deregulation was that ‘free market’ maniacs were banging on about governments running balanced budgets ‘ like a household’ and many governments tried to do that. The hallmark of an “economic adult” government during this period was whether they were getting close to or had achieved a budget surplus.
In other words, during the period that the banks were going mental and creating credit hand over fist the public sector was trying as hard as possible to avoid creating credit (a budget deficit amounts to the creation of public credit). Not surprisingly they were egged on by the mainstream press paid for and subservient to private banking sponsorships. Nothing less than the complete privatisation of public money creation was the goal.
So while there was money creation happening on a grand scale during the deregulation period most of it was not by government…at least not until they started clocking up massive debts as they tried to bail out their private banking systems and revive economies suffering the effects of going private bank credit ‘cold turkey’.
Will return to a Gold Standard help?
The attractions of a gold standard are obvious.
Gold is hard to find and therefore if we tie our public monetary system to quantities of gold that should prevent out of control money creation. If you want to create new money you better grab a shovel and dig some up.
The difficulty with a Gold Standard is that gold is not that useful to use as money unless you are into bling and don’t mind chopping off a gram or two when you pay for the groceries. So when people talk about a Gold Standard they are really talking about using some sort of certificate / bit of paper that represents a claim on some physical gold in a vault somewhere.
But once you are talking about using bits of paper that represent a claim on some gold in some vault you are back in the territory of trust and confidence. Do you trust the organisation issuing the certificate / claim to actually have the physical gold and be willing to deliver it on demand when you want it?
In the lead up to the GFC and after the GFC a topic of hot conversation on websites about gold was whether there was gold in certain well known vaults and whether, when push came to shove, your ‘gold supplier’ would actually deliver on the certificate / receipt they had issued. Gold suppliers like Perth Mint went to great pains to explain how your chunk of gold was resting happily waiting for you when the time came.
Considering that banking got its bad reputation because its business model originally involved issuing more ‘receipts’ for gold to be produced on demand than was in the vault, it is hard to see how a return to a Gold Standard would allow anyone to rest easily.
This does not mean that gold and gold certificates do not have a role to play. Gold is hard to find and as yet the alchemists have not succeeded in creating gold (they switched to double entry bank accounting centuries ago). This means that it is perfectly valid for people to want to prefer to use gold or claims on gold as money.
However, that is not the same as requiring that gold or claims on gold be adopted as the basis of the public monetary system.
Bearing in mind that adoption of a Gold Standard will inevitably involve trust as to whether:
(a) the gold backing the claims on gold actually exists in a vault
(b) the gold will be produced on demand if required
It seems simpler to just accept that as a public monetary system is nothing more than trust that the full faith and credit of the nation stands behind its public money, the critical thing is making sure that the public monetary system is not being molested by a bunch of profit seeking private parties.
In other words our public monetary system does not need to be gold based but it does need to have the private bankers expelled from any role in relation to public money creation as fast as possible.
Removing the private bankers from the public monetary system.
There are many ways to end the disaster that has been the era of deregulated private bank credit creation as public money but in general the common features are:
- Re-regulate private bank credit creation to ensure that it serves the public interest and democratically determined resource allocation objectives rather than the asset price speculating and bonus hunting interests of a minority.
- Introduce a entirely public system of deposit accounts so that every citizen has the ability to save and transact without needing to have a ‘relationship’ with a private bank who then uses that relationship to data mine.
- Progressively tighten the regulation of bank credit creation and reserve requirements until the banks power to create public money in the form of bank credit has been completely lost. At that point a bank will be no different to any other financial sector organisation. They will seek funds from investors and then invest those funds on terms consistent with the terms on which the investors advanced them.
- Encourage / permit private forms of money – e.g. Gold backed certificates, cryptos etc – so there is plenty of competition and alternatives to the now entirely public ‘public’ money.
Allowing private banks a role in the monetary system by giving their credit equal status to credit created by the public was always a terrible mistake and should be consigned to the history books as a barbaric economic relic.
Any doubts about this should have been erased by the experiences of the last 30-40 years when private bank credit creation was effectively deregulated and let loose to create havoc across the globe.
While the appeal of a Gold Standard is understandable it is unlikely to be a solution unless we understand that the fundamental problem was the role of the banks in the public monetary system and the damage caused by the way private bankers abused their privilege.
Removing the role of the private banks in the public monetary system while encouraging the private sector to offer competing private monetary ‘trust’ products, including options involving gold and gold backed claims, would seem the best step forward and the best way to keep the public money ‘honest’ and healthy.
Except banks were not deregulated, they were turned into a private oligopoly. The regulatory burden for banking, and the licences required to carry it out ensures this.
A real free market would see tens of thousands of banks. Who wouldn’t want to have the power to create money?
There is an argument to be made that natural monopolies, i.e. utility functions, should be managed centrally rather than concentrated into a few private hands. Neither of those solutions have worked out well.
The answer is not deregulation, but decentralisation, which diversifies ownership of the monopoly good, and breaks the monopoly. Given the fight against the decentralisation of energy generation, it is obvious that our government has no interest in the stability or robustness of our economy, but simply serves the interests of the the 1%.
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“..Except banks were not deregulated, they were turned into a private oligopoly. ..”
It is worse than that. My reference to deregulated banks is a reference to their credit creation powers in the context of the status given to that credit creation by the state. In effect what we have is a highly centralised state/private bank partnership. As you note the consequences are not good regardless of who from time to time has the ‘whip’ in the partnership. Deregulation means that the private banks are dominating the partnership. Credit regulation means the state is dominating. At the moment in Australia we are probably seeing a slight shift back to the state as a result of the Banking Royal Commission.
Decentralising the power over money is definitely a better alternative.
There are many forms that can take but the key is a mix between a wide range of private money and public money (not necessarily just at the national level).
Yes, trust is golden, but is a return to the ‘barbaric relic’ necessary to restore trust in fiat after “the damage caused by the way private bankers abused their privilege”?
Governments’ resolve in protection of confidence in their currency should be sufficient.
Perhaps in Australia, the problem will not be addressed (now manifest (as elsewhere) in private banks’ recklessness, crypto, gig-economy, etc) until the housing market crashes. The imperative then will be for the Govt to administer the restructure of all the insolvent private banks into good/bad banks. Good banks will be amalgamated into a public savings bank (‘myRBA’?) into which only depositors’ funds liabilities and personal home-loan assets are transferred. The ‘bad’ banks will be wound-up with losses to their commercial creditors, thereby providing a widely-disseminated lesson in the risk of involvement in a fractional-banking system. Regrettably, the learnings last only for 2 generations.
Private banks (and fractional banking) for commercial lending need not be proscribed (as who can argue against the laissez-faire results achieved in British Hong-Kong) but without govt-guarantee!
Let them profit in the next boom, and die in the subsequent bust. Unless we become reliant on banking services as an export industry (viz UK) why should most Australians be affected?
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