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Traktion

Is Risk Allocation The Problem With The Way We Bank?

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Having read a number of threads recently and considered the problems with bubbles/booms/busts. They happened in the days when a full reserve banking model was used. They still happen in the fractional reserve banking model - we have perhaps only seen a small part of this bust too.

With full reserve banking (along with the gold standard) when a bubble popped, it wiped out not just the foolish investors, but also the banks and the other people banking with them. There was no borrowing from the future to bail anyone out - innocent people with savings were left out to dry after bank runs.

With fractional reserve banking (along with fiat currency) when a bubble pops, the future tax payer funds the bailout, along with the cash rich via inflation. Although the suffering is less acute per person, everyone ends up paying a share due to the folly of a few, even those not yet born.

Clearly, neither system is ideal. Why should everyone suffer at the hands of the few greedy, foolish people? Both of the above have parallels though - we are lead to believe that banks are 100% safe and our money will always be there, when in fact they are not.

Our only benefit in the above systems is that we get given some sort of interest on our money. As inflation now erodes the value of our money, we are essentially forced to use banks in order to retain our wealth. However, how can banks be sure that their investments represent safe investments? How do they know that they will not lose money? How can they guarantee any sort of return or safety unless the government provides a back stop?

My position is that I would like to see sound money - money which stores wealth. £100 now would be £100 in 100 years. With this in mind, I would like to see some sort of full reserve banking, but I have outlined the problems with bubbles above. As a result, I would argue we need a system where we can opt in or out of speculative investment banking.

I mentioned this on another thread, but I think it is important to consider it again. We should have the following:

1. Sound and stable money supply - no inflation. [EDIT: ie. inflation of the money supply - this is nothing to do with price index inflation]

2. Savings banks where your money is just looked after. Access to traditional cards, ATM, direct debits etc provided. None of this money can be touched by the bank for investment. There could even be a storage fee if needed, but the market could decide that. The point is - this money would not be touched by the banks. Any bank run will return all money to the rightful owners as it is all accounted for. As there is no monetary inflation, there is no need for interest payments - the money retains its worth.

3. Speculative banks where your money is used to form bank loans and investments. There is a risk of losing some/all of your money in such banks and the saver would have the choice between many institutions offering various levels of risk. People would be free to seek big gains, but they may end up with big losses.

Some people just want their money safe, which 1 provides. Some people may split between 1 and 2, hedging their bets a little. Some born gamblers will stick it all in risky banks, predicting high returns, using 2.

What is the point? If a speculative bank invests poorly, their savers lose money. They may even withdraw it. A bank run may even happen and some will be left with nothing. This is the gamble you acknowledge when you deposit in such an account. The flip side is that no tax payers are brought in to bail anyone out and no inflation is pushed through to rob people of wealth. No savings banks (1.) are touched, so the cautious person is left safe.

Businesses still get their money, but the risk is passed right down the line. No investment is 100% safe, so allowing the banks to attempt this is folly. All we can do is assign the fall out of bad risk fairly and proportionally. Thoughts?

Edited by Traktion

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About the only choice you'll ever have for your £100 toady equals £100 tomorrow system is going to be gold and even thats all swings and roundabouts... or govt paper I suppose.. or NSand I..... I can't see the banking system changing in a hurry.

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About the only choice you'll ever have for your £100 toady equals £100 tomorrow system is going to be gold and even thats all swings and roundabouts... or govt paper I suppose.. or NSand I..... I can't see the banking system changing in a hurry.

It matters not which they use to create a stable money supply. The point is, bubbles can hurt all those at a bank unless risk is considered right down to the saver. If this is done, only those willing to take the risk are hurt by poor risk management at the banks.

With full reserve, all those who use the bank are at risk, but the argument was made that with fractional reserve banking, we all get our money back - the caveat being it may not be worth as much indirectly (due to inflation and tax rises).

EDIT: The words actually make sense now :blink:

Edited by Traktion

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I like it, but I'm not clear on whether the safe bank is guaranteed by the taxpayer and that speculation of deposits is illegal, or that neither bank is guaranteed? I would prefer that neither bank is guaranteed and the market can provide whatever banking people choose.

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2. Savings banks where your money is just looked after. There could even be a storage fee if needed

What happens if activity in the "speculative banking sector" causes inflation? So you must either accept this risk for zero return, or else opt out of notes and coints by buying something tangible (as stated @#3). But surely not invest in government debt - they are just going to recycle your cash for speculative investment, just as at any bank :lol:

3. Speculative banks where your money is used to form bank loans and investments. There is a risk of losing some/all of your money in such banks and the saver would have the choice between many institutions offering various levels of risk. People would be free to seek big gains, but they may end up with big losses.

It would be possble to have a half-way house as well. Just as, at the moment, if you dont want to invest in arms manufaturers or tobacco, you can bank with the Co-op, it would be nice to be able to choose banks based on their line of lending. E.g. choose to invest in a bank/BS which only lends to trading businesses and doesn't offer mortgages. The lending criteria and reserve policy could be fixed for a given bank (or sub-fund of deposits), so you know what you are getting when you deposit money there.

Such banks may not be that diversified but they wouldn't have to lend out a high % of their deposits to pay a competitive rate of interest in the current market.

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What happens if activity in the "speculative banking sector" causes inflation? So you must either accept this risk for zero return, or else opt out of notes and coints by buying something tangible (as stated @#3). But surely not invest in government debt - they are just going to recycle your cash for speculative investment, just as at any bank :lol:

It would be possble to have a half-way house as well. Just as, at the moment, if you dont want to invest in arms manufaturers or tobacco, you can bank with the Co-op, it would be nice to be able to choose banks based on their line of lending. E.g. choose to invest in a bank/BS which only lends to trading businesses and doesn't offer mortgages. The lending criteria and reserve policy could be fixed for a given bank (or sub-fund of deposits), so you know what you are getting when you deposit money there.

Such banks may not be that diversified but they wouldn't have to lend out a high % of their deposits to pay a competitive rate of interest in the current market.

Without a State guarantee, activity in the speculative sector would not cause inflation because their credit would lose value accordingly, cheques written against that bank would be worth less than face value.

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I like it, but I'm not clear on whether the safe bank is guaranteed by the taxpayer and that speculation of deposits is illegal, or that neither bank is guaranteed? I would prefer that neither bank is guaranteed and the market can provide whatever banking people choose.

My thoughts would be that the safe bank cannot be raided/invested or otherwise touched by the banks. Therefore, there would be no need for guarantees - the money would just wait there.

For the speculative, there would be no guarantees either, which is why there would be risk to the saver who uses such banks.

The idea is that the government never needs to step in as for the safe bank, as the money would always be there. In a speculative bank, the risk is taken by the saver, who is aware of potential losses when they deposit their cash.

EDIT: re-worded.

Edited by Traktion

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My thoughts would be that the safe bank cannot be raided/invested or otherwise touched by the banks. Therefore, there would be no need for guarantees - the money would just wait there.

For the speculative, there would be no guarantees either, which is why there would be risk to the saver who uses such banks.

The idea is that the government never needs to step in as for the safe bank, as the money would always be there. In a speculative bank, the risk is taken by the saver, who is aware of potential losses when they deposit their cash.

EDIT: re-worded.

I'm a supporter, how would you get there... what would you do with all the existing malinvestment or do you start with a new currency?

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What happens if activity in the "speculative banking sector" causes inflation? So you must either accept this risk for zero return, or else opt out of notes and coints by buying something tangible (as stated @#3). But surely not invest in government debt - they are just going to recycle your cash for speculative investment, just as at any bank :lol:

Activity in the speculative banking sector would likely to be largely cyclic, with times of gain and times of loss. This may affect your buying power (ie. price index inflation) at different times, but over a (or many) business cycles, I would expect things to even out. To be explicit, your safe banks would gain in times of credit contraction, but lose during expansion. I can't think of away around this, as demand for money changes over a business cycle. Unless people know otherwise?

I see your point about not being able to take things in isolation, but compared to the credit inflation/deflation we have now, the affects would be smaller - there is only so much money you can lend if it is backed by real money (and not created as debt).

It would be possble to have a half-way house as well. Just as, at the moment, if you dont want to invest in arms manufaturers or tobacco, you can bank with the Co-op, it would be nice to be able to choose banks based on their line of lending. E.g. choose to invest in a bank/BS which only lends to trading businesses and doesn't offer mortgages. The lending criteria and reserve policy could be fixed for a given bank (or sub-fund of deposits), so you know what you are getting when you deposit money there.

Such banks may not be that diversified but they wouldn't have to lend out a high % of their deposits to pay a competitive rate of interest in the current market.

Yes, good ideas. It could be quite liberating to have the choice of where the money is going to go. You could have some banks which are big on local investment too, which may appeal to many.

Actually, I think that is another good point - local banks dealing with local businesses again could be a good idea. If you want a safe investment, it is best to know what the company does and who runs it. It may be that a community would benefit from both the safety (of investment) and the benefits which the business brings (local jobs, services etc).

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I'm a supporter, how would you get there... what would you do with all the existing malinvestment or do you start with a new currency?

That's a good question and I don't know if there is a simple answer. But I'll have a crack at some ideas.

Nationalise the failed banks and start to replace credit money with fiat money, created by the BoE. Any credit money replaced is matched by an equal (or slightly higher to allow some deflation) increase in reserve ratio. The result being a cancellation of the credit, with no new fiat money being let out into the system. Assuming* (!) the markets remain un-phased by this, the price indexes would remain the same, essentially baking in the current prices. Then plot a course for the remaining private banks to return to 100% reserve ratios over a series of years, allowing any other banks to either fail or be treated like the above.

A debt jubilee is another simple way, but I should imagine there would have to be global agreement of some sort or the market/exchange rates could go nuts. Money owed to other countries could cause fractions/war etc. So, maybe this way would not be so easy. I think I prefer the above.

The important thing is letting go of what we have now. While we hang on to it, things will just stagnate and get grimmer and grimmer. A slow necromancy of debt and deflation, destroying and/or forcing out any remaining industries to more competitive countries. Once we let go, we can liberate ourselves to think of how to get to the next step, rather than waiting in denial. I'm not sure if the above is the best idea to get to the next step, but I just want to put it out there.

Of course, the void left behind these failed banks would need filling. It would be easy to start up a safe bank - it just looks after money and conventional services. It is essentially money warehousing, except most of it would be done via computers anyway (as it currently is). Alternatively, surviving banks would be well equipped to take this on.

The speculative side need provide no services. Money may be locked for periods of time and there would be no need for services (cards, ATMs etc) which the safe banks would handle. Anyone can invest money, so this would be an industry which current banks and investors are familiar with.

*The markets could go nuts and run on the pound, of course. Exchange rates could go loopy - it is hard to know what would happen.

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That's a good question and I don't know if there is a simple answer. But I'll have a crack at some ideas.

Nationalise the failed banks and start to replace credit money with fiat money, created by the BoE. Any credit money replaced is matched by an equal (or slightly higher to allow some deflation) increase in reserve ratio. The result being a cancellation of the credit, with no new fiat money being let out into the system. Assuming* (!) the markets remain un-phased by this, the price indexes would remain the same, essentially baking in the current prices. Then plot a course for the remaining private banks to return to 100% reserve ratios over a series of years, allowing any other banks to either fail or be treated like the above.

A debt jubilee is another simple way, but I should imagine there would have to be global agreement of some sort or the market/exchange rates could go nuts. Money owed to other countries could cause fractions/war etc. So, maybe this way would not be so easy. I think I prefer the above.

The important thing is letting go of what we have now. While we hang on to it, things will just stagnate and get grimmer and grimmer. A slow necromancy of debt and deflation, destroying and/or forcing out any remaining industries to more competitive countries. Once we let go, we can liberate ourselves to think of how to get to the next step, rather than waiting in denial. I'm not sure if the above is the best idea to get to the next step, but I just want to put it out there.

Of course, the void left behind these failed banks would need filling. It would be easy to start up a safe bank - it just looks after money and conventional services. It is essentially money warehousing, except most of it would be done via computers anyway (as it currently is). Alternatively, surviving banks would be well equipped to take this on.

The speculative side need provide no services. Money may be locked for periods of time and there would be no need for services (cards, ATMs etc) which the safe banks would handle. Anyone can invest money, so this would be an industry which current banks and investors are familiar with.

*The markets could go nuts and run on the pound, of course. Exchange rates could go loopy - it is hard to know what would happen.

Good comments. I guess it breaks down into what you do with the savers against what you do with the debtors; you can forgive the debtors (a jubilee) but the savers would want to be compensated for their bank deposits... If you keep the debt and replace the bank credit with real notes, this makes everyone whole and restores the system to continue as it should with no continuing State guarantee, as you describe. If even if you do want to save the system in this way it would meaning printing Trillions of new money and all of the creditors would be apoplectic even though they would only be being given what they are owed so ignorance of the system makes this politically impossible, just see what reaction £100bn or so of QE gets, even on these boards where people are quite savvy.

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Without ANY FORM of state guaranty, the problem solves itself as people will be more interested in what their banks are doing with their money and stupid banks making stupid bets wont get any deposits.

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1. Sound and stable money supply - no inflation.

How about deflation (i.e cheaper prices) due to increases in performance and efficiency. Is this allowed or should it be similarly regulated against because it alters the purchasing power of the national currency.

Edited by chefdave

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If even if you do want to save the system in this way it would meaning printing Trillions of new money and all of the creditors would be apoplectic even though they would only be being given what they are owed so ignorance of the system makes this politically impossible, just see what reaction £100bn or so of QE gets, even on these boards where people are quite savvy.

I have often wondered about this. Presumably depositors dont believe a jubilee is very likely (or are unaware)- otherwise they would have already (tried to) withdraw all of "their" money out of the bank and switch into another currency or assets.

I dont see how you can get around the subsequent rise in asset prices (unless you give creditors some equity in the assets that are backing loans)

The obstacles to scrapping the current system are a bit like the obstacles, say, to a peace process. Nobody willing to forget past (mis)deeds or make concessions on things that that they have fought for.

Actually, I think that is another good point - local banks dealing with local businesses again could be a good idea.

I feel a slogan coming on.... "Local banks for local business" ..... sorry ;)

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Without ANY FORM of state guaranty, the problem solves itself as people will be more interested in what their banks are doing with their money and stupid banks making stupid bets wont get any deposits.

The problem is, when a stupid bank has a bank run, it affects everyone saving with them. If one of the big borrowers bets everything on red, and black turns up, triggering a bank run, why should there be those who at the back of the run-queue that end up with nothing?

If there is one thing this crisis has shown, it's that banks can't be trusted. They will take gambles, rake of the profits and to hell with anyone who loses out. The government then steps in and the whole sorry affair struggles on.

How about deflation (i.e cheaper prices) due to increases in performance and efficiency. Is this allowed or should it be similarly regulated against because it alters the purchasing power of the national currency.

Why would deflation need to be regulated? Stuff getting cheaper through efficiencies is good!

Also, you miss my point about inflation. I'm not talking about price index inflation (CPI, RPI) but monetary base inflation. As lending is from deposits, it would also keep credit inflation under control (banks could only lend out what they have).

The main thing is not to control the purchasing power of the currency (the market decides that), but to provide stable foundations. If input costs go up or down, that is just the market doing what the market does. No amount of printing is going to help if the price of resources go up around the world (through scarcity through under supply or high demand) - it will just debase the currency. I'm not sure who you could steal it back off to destroy this money again. Tinkering with the money supply may benefit some and cost others - they should just leave it alone.

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The problem is, when a stupid bank has a bank run, it affects everyone saving with them. If one of the big borrowers bets everything on red, and black turns up, triggering a bank run, why should there be those who at the back of the run-queue that end up with nothing?

Because they gave their money away foolishly without checking.

If there is one thing this crisis has shown, it's that banks can't be trusted. They will take gambles, rake of the profits and to hell with anyone who loses out. The government then steps in and the whole sorry affair struggles on.

That's right. Yet people still give them money.

Why?

Because the state makes it all better for them when they lose.

Why would deflation need to be regulated? Stuff getting cheaper through efficiencies is good!

Also, you miss my point about inflation. I'm not talking about price index inflation (CPI, RPI) but monetary base inflation. As lending is from deposits, it would also keep credit inflation under control (banks could only lend out what they have).

The main thing is not to control the purchasing power of the currency (the market decides that), but to provide stable foundations. If input costs go up or down, that is just the market doing what the market does. No amount of printing is going to help if the price of resources go up around the world (through scarcity through under supply or high demand) - it will just debase the currency. I'm not sure who you could steal it back off to destroy this money again. Tinkering with the money supply may benefit some and cost others - they should just leave it alone.

Theres the problem righ tthere - too much profit in messing with any system you create.

That's why any system should be based on free choice and messing about. People don;t like risk, but tough it's there and nothing can be done about it.

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Good comments. I guess it breaks down into what you do with the savers against what you do with the debtors; you can forgive the debtors (a jubilee) but the savers would want to be compensated for their bank deposits... If you keep the debt and replace the bank credit with real notes, this makes everyone whole and restores the system to continue as it should with no continuing State guarantee, as you describe. If even if you do want to save the system in this way it would meaning printing Trillions of new money and all of the creditors would be apoplectic even though they would only be being given what they are owed so ignorance of the system makes this politically impossible, just see what reaction £100bn or so of QE gets, even on these boards where people are quite savvy.

I think the straight debt jubilee idea is probably more than people could stomach, even if it did release the economy from it's shackles. I think it is a potential option, but it would be pretty unfair for anyone who has lived within their means. Like I said, if needs must, it could be an option, but I think we would have to be in a truly desperate state.

In terms of replacing credit with real money, there are ways and means to nudge towards it. For instance, we could use QE money to create a good bank, or even use Northern Rock as a vehicle to inject QE money straight into. They could floor the interest rates, tighten up the lending multiples and push mortgage holders towards the state owned bank. As QE is printed anyway, they could just set rates to the 0.5% base rate (which the general public assume they should be!) and set the multiples to 2x+1x or 3x (explaining this is for their own good). Once people are used to the idea that it is a national bank, telling the public that they are repaying the public owned debt with public money should (at least, could) be easy.

I mentioned this in another thread, as current UK banks have lent at an average of 33:1, providing state mortgages for all the £1 trillion or so of mortgage debt isn't too tall an order. Print up £30 billion in QE (or even just plain printing - why be coy?), put it in the state bank and I think all the bases are covered. Unless I'm missing something, the government will be just beating the banks at their own game. The difference is, they have the advantage of being able to add enough base money as they need, interest free.

Ok, adding £30 billion to the base capital (which was said to be between £50-75 billion before QE, I believe) now could be considered inflationary, it would pale into insignificance compared to the £125 billion of QE already about to cause massive increases in potential broad money anyway! The question I have is why did they push so much QE into the system to support the existing banks, when they could have created their own, with less potential for inflation too?

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Why would deflation need to be regulated? Stuff getting cheaper through efficiencies is good!

What you want to do is fix the value of the currency so that it retains its worth. If this is arranged so that £1=1 loaf of bread for the next hundred years then you effectively ride roughshod over any idea of a free market.

Also, you miss my point about inflation. I'm not talking about price index inflation (CPI, RPI) but monetary base inflation. As lending is from deposits, it would also keep credit inflation under control (banks could only lend out what they have).

If you're not interested in the price of stuff then it seems to me that you're lost. For me the price of an item is the single most important aspect of economics. If you took a bottle of coke from the supermarket and analysed all the costs of production right through the chain until the point of sale I'm sure it would yield some interesting and valuable results. All we really need to know is this: who gets what and how do they get it based upon their contribution to the productive process.

Limiting the process of credit creation has its drawbacks because the implicit assumption is that more money means devalued money. Well this is nonsense, if the population of Britain doubled overnight for example the money supply could quite easily be increased by a third without any loss of purchasing power to holders of current £'s.

The main thing is not to control the purchasing power of the currency (the market decides that), but to provide stable foundations. If input costs go up or down, that is just the market doing what the market does. No amount of printing is going to help if the price of resources go up around the world (through scarcity through under supply or high demand) - it will just debase the currency. I'm not sure who you could steal it back off to destroy this money again. Tinkering with the money supply may benefit some and cost others - they should just leave it alone.

Perhaps the market should decide how much credit it needs too then.

Edited by chefdave

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What you want to do is fix the value of the currency so that it retains its worth. If this is arranged so that £1=1 loaf of bread for the next hundred years then you effectively ride roughshod over any idea of a free market.

No - you just create a certain amount of currency and then leave it alone. The market will dictate how much bread, gold, liver, fish or whatever you want to buy. The number of loaves of bread, beers, oil or anything else adjusts in relation to one another too. You can't just legislate the price of a loaf of bread any more than you can a litre of oil.

If you're not interested in the price of stuff then it seems to me that you're lost. For me the price of an item is the single most important aspect of economics. If you took a bottle of coke from the supermarket and analysed all the costs of production right through the chain until the point of sale I'm sure it would yield some interesting and valuable results. All we really need to know is this: who gets what and how do they get it based upon their contribution to the productive process.

Limiting the process of credit creation has its drawbacks because the implicit assumption is that more money means devalued money. Well this is nonsense, if the population of Britain doubled overnight for example the money supply could quite easily be increased by a third without any loss of purchasing power to holders of current £'s.

It is not that I am disinterested in the price of things, it is just that there is little one can do about it. If bread gets expensive, you can't print more money to make it cheaper. You may be able to cut tax on it or some such, but this has little to do with the amount of money in circulation. Sure, it's interesting to see a price index and see what is going up or down and why, but it is little to do with the number of pounds in circulation.

So you are insinuating that the increase in credit made available for houses hasn't devalued the rest of the money in circulation? Has my house magically gained 3 times in value in a decade or so because it has found a new talent to generate money? Of course not - it is because there was loads more credit being dished out to chase the same houses. If this was not the case, why would a credit crunch cause houses to devalue?

Also credit does produce temporary monetary inflation. It is added when the load is created and gradually deflates again as it is paid off. If the credit limit is increased year after year (which it has - look at the UK reserve rations over the last few decades: http://en.wikipedia.org/wiki/Reserve_requirement) then inflation just keeps on building up. There should be a blow off phase when credit is repaid, but by constantly stoking lending, we've built a mountain of debt which is unsustainable. They are even trying to stave off deflation by printing more base capital for the banks to lend from. The money supply is trying to deflate again, but they're fighting with everything they have got to stop it.

As for doubling the population (as well as productivity), you are essentially doubling the purchasing power of the currency too. If there are more people, there is more demand for the money, so the value increases. If the population halves (as well as productivity), so does the demand for the money, so the value decreases.

Essentially, the value of the currency is backed by the productivity of the people who use it. Prices of goods will rise and fall against this, but they will remain relative. The population may halve, your salary may double, but then so may the bread you want to buy. Alternatively, the population may double, your salary may halve, but then so may the bread you want to buy. What is important is that everything remains the same price relative to everything else.

Importantly, efficiencies in the system wouldn't be seen as something to fight with interest rates, increasing the money supply or anything else. The efficiencies are just received with the pleasure they should be - they make the items which benefit cheaper in relation to other items.

Perhaps the market should decide how much credit it needs too then.

From money created out of thin air? Recent history has shown that people will borrow as much as they can until they are saturated. Then what happens? I believe that is where we are now and it doesn't look too pretty.

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No - you just create a certain amount of currency and then leave it alone. The market will dictate how much bread, gold, liver, fish or whatever you want to buy. The number of loaves of bread, beers, oil or anything else adjusts in relation to one another too. You can't just legislate the price of a loaf of bread any more than you can a litre of oil.

Of course not but what you're seeking to do is control the amount of risk taking thats allowed in the economy by manipulting the money supply. Risk taking would become a privilege which could then be monopolized and expoited for the purpose of rent seeking:

Rent seeking generally implies the extraction of uncompensated value from others without making any contribution to productivity, such as by gaining control of land and other pre-existing natural resources, or by imposing burdensome regulations or other government decisions that may affect consumers or businesses.

http://en.wikipedia.org/wiki/Rent_seeking

It is not that I am disinterested in the price of things, it is just that there is little one can do about it. If bread gets expensive, you can't print more money to make it cheaper. You may be able to cut tax on it or some such, but this has little to do with the amount of money in circulation. Sure, it's interesting to see a price index and see what is going up or down and why, but it is little to do with the number of pounds in circulation.

I thought the thrust of your argument was to control inflation?

So you are insinuating that the increase in credit made available for houses hasn't devalued the rest of the money in circulation? Has my house magically gained 3 times in value in a decade or so because it has found a new talent to generate money? Of course not - it is because there was loads more credit being dished out to chase the same houses. If this was not the case, why would a credit crunch cause houses to devalue?

Your currency has only been devalued against housing, its stood up pretty well against almost anything else you want to purchase which suggests that the problem lays solely with the housing market, wouldn't you agree? The combination of a land cartel and a laissez faire banking system is a toxic mix i'll admit, but if you withdrew the credit it would effectively shut many more people out of the housing market altogether. This would be politically embarrassing and so the masses have been offered cheap money as a crude solution to the injustices present in the land market.

Also credit does produce temporary monetary inflation. It is added when the load is created and gradually deflates again as it is paid off. If the credit limit is increased year after year (which it has - look at the UK reserve rations over the last few decades: http://en.wikipedia.org/wiki/Reserve_requirement) then inflation just keeps on building up. There should be a blow off phase when credit is repaid, but by constantly stoking lending, we've built a mountain of debt which is unsustainable. They are even trying to stave off deflation by printing more base capital for the banks to lend from. The money supply is trying to deflate again, but they're fighting with everything they have got to stop it.

It was ok until the housing market turned, once this happened the banks no longer had the collateral to cover their liabilities. Whats important to note though is that it's the land market that controls the banks; not the other way around. They can't prop up prices because the housing market works on its own dynamic.

As for doubling the population (as well as productivity), you are essentially doubling the purchasing power of the currency too. If there are more people, there is more demand for the money, so the value increases. If the population halves (as well as productivity), so does the demand for the money, so the value decreases.

Essentially, the value of the currency is backed by the productivity of the people who use it. Prices of goods will rise and fall against this, but they will remain relative. The population may halve, your salary may double, but then so may the bread you want to buy. Alternatively, the population may double, your salary may halve, but then so may the bread you want to buy. What is important is that everything remains the same price relative to everything else.

Importantly, efficiencies in the system wouldn't be seen as something to fight with interest rates, increasing the money supply or anything else. The efficiencies are just received with the pleasure they should be - they make the items which benefit cheaper in relation to other items.

Fixing the money supply in this way would create artificial shortages and exclude many people from the economic advantages that others enjoy. The demand for capital and credit would eventually fall into the hands of the black market where interest rates would be usurious and baseball bats would be used in place of the law courts. Money - like any other form of capital - needs to created when it is needed, the drawbacks for limiting this natural and desirable state of affiars would be enormous opportunity costs.

From money created out of thin air? Recent history has shown that people will borrow as much as they can until they are saturated. Then what happens? I believe that is where we are now and it doesn't look too pretty
.

Yes money created from thin air. As Injin said, you can't regulate against risk. Its there and there's nothing you can do about it. What you can do though is minimize the negative activities of the housing market which is used at present to hoover up surplus value from those that are creating it.

Edited by chefdave

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I've also been thinking about this recently, so it's good to see others posting on it.

Being someone who is careful with my money I too resent the idea that I will often be forced to pay for other people's folly. The idea of a full reserve, not for profit, no inflation banking service is something I would use for daily activities and storing money, whilst I make decisions on how best to use it. The not-for-profit bit fits in with my view of money as more of an essential utility and thus I would be happy to see this service as part of the state. Open to other suggestions though.

With regard to what would then become savings and investments banks, wouldn't they simply become brokers? So do they need to offer any banking services at all. Although offering choice is important for those that want the risk for all of their money. The most important part is that these banks have no guarantees or support from the state whatsoever.

It would be possble to have a half-way house as well. Just as, at the moment, if you dont want to invest in arms manufaturers or tobacco, you can bank with the Co-op, it would be nice to be able to choose banks based on their line of lending. E.g. choose to invest in a bank/BS which only lends to trading businesses and doesn't offer mortgages. The lending criteria and reserve policy could be fixed for a given bank (or sub-fund of deposits), so you know what you are getting when you deposit money there.

Such banks may not be that diversified but they wouldn't have to lend out a high % of their deposits to pay a competitive rate of interest in the current market.

Regardless of the final outcome this is a step I'd like to see happen now. Whilst I ultimately agree with Injin that people who don't bother to check where they put their money are still responsible win, lose or draw. The evil part is that the system is almost inescapable without causing yourself some hardship. I see no reason why a few legal requirements can't make it easier for everyone to make informed choices, and avoid later arguements about mis-selling or fraud. Having banks forced to declare all possible benificiaries and investments that their money will or might be used for. In 9ft letters if necessary. Reconnecting people with what they are actually supporting will increase democracy in the economy (if that makes sense). Informed choices will giver a truer valuation of industries.

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No - you just create a certain amount of currency and then leave it alone. The market will dictate how much bread, gold, liver, fish or whatever you want to buy. The number of loaves of bread, beers, oil or anything else adjusts in relation to one another too. You can't just legislate the price of a loaf of bread any more than you can a litre of oil.
Of course not but what you're seeking to do is control the amount of risk taking thats allowed in the economy by manipulting the money supply. Risk taking would become a privilege which could then be monopolized and expoited for the purpose of rent seeking:

http://en.wikipedia.org/wiki/Rent_seeking

I have read the link and I don't see the connection. Are you saying that allowing the market to share out a fixed amount of money is in some way is unfair to a section of society?

People can risk any money they like - they can go to the races, invest in stocks and shares, stick it on red on roulette. They can even put it in a bank and ask them to risk some on investments. Why are you saying I am in some way limiting the amount of risk they are allowed to take? It is their money and they can do what they like with it. I don't know how much more explicit I can be about this.

I am merely saying not every bank account should be presented as risk free. There are risks in investing money, but there is little risk in leaving as untouched numbers on a bank computer.

I thought the thrust of your argument was to control inflation?

Only inflation of the money supply. To be clear and to avoid confusion: I would advocate adding no more money to the supply, nor removing any. Again, I don't know how much more clearly I can state this.

I would have no desire to monitor or make monetary policy up based on the price of carrots or Haribos (ie. price inflation indexes like CPI/RPI). The price of these may change due to external (exchange rate, supply/demand changes etc) factors.

These are two very different things and the two are not inter-changeable. I have added a note to my first post to make this as clear as I can.

Changes in population would have a small effect on these price indexes too, but this changes so little, it would be a small interference. Population change would not cause prices to adjust relative to one another though (they would essentially be in lock step, ignoring other external factors).

Your currency has only been devalued against housing, its stood up pretty well against almost anything else you want to purchase which suggests that the problem lays solely with the housing market, wouldn't you agree? The combination of a land cartel and a laissez faire banking system is a toxic mix i'll admit, but if you withdrew the credit it would effectively shut many more people out of the housing market altogether. This would be politically embarrassing and so the masses have been offered cheap money as a crude solution to the injustices present in the land market.

It was ok until the housing market turned, once this happened the banks no longer had the collateral to cover their liabilities. Whats important to note though is that it's the land market that controls the banks; not the other way around. They can't prop up prices because the housing market works on its own dynamic.

If you withdrew all credit, what do you think would happen to house prices then? Do you think they would stay the same and the rich would buy them all up?

I don't argue that the distribution of land is unfair - I have commented on this in other threads - but credit has clearly fuelled the high prices.

If the land market controls the banks, how come the prices dropped when credit dried up?

Fixing the money supply in this way would create artificial shortages and exclude many people from the economic advantages that others enjoy. The demand for capital and credit would eventually fall into the hands of the black market where interest rates would be usurious and baseball bats would be used in place of the law courts. Money - like any other form of capital - needs to created when it is needed, the drawbacks for limiting this natural and desirable state of affiars would be enormous opportunity costs.

How do you create an artificial shortage from only allowing something which exists to be shared out? I would argue the flip side - lending out something you don't have creates artificial supply.

As for the black market, that is just scaremongering. Credit is always in restricted supply, by interest rates and credit ratings. Is this driving people to the black market or are people just instead trying to live within their means?

Do you think money is in some way special to other items? Productivity can't be created out of thin air, so why should the currency which represents it? If I do a day's work, how can you lend my productivity out 32 times?

.

Yes money created from thin air. As Injin said, you can't regulate against risk. Its there and there's nothing you can do about it. What you can do though is minimize the negative activities of the housing market which is used at present to hoover up surplus value from those that are creating it.

The point that you can't regulate risk is exactly why you need speculative banks. The inherent risk can cause you to lose or gain money, based on your investment stake. A return cannot be guaranteed, only estimated/targeted.

However, if I store something in a safe, I expect it to still be there when I go to fetch it. I also don't expect anyone to have borrowed it, risked losing it and then put it back without my permission. This is the principle of the risk free, safe banking.

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I have often wondered about this. Presumably depositors dont believe a jubilee is very likely (or are unaware)- otherwise they would have already (tried to) withdraw all of "their" money out of the bank and switch into another currency or assets.

I dont see how you can get around the subsequent rise in asset prices (unless you give creditors some equity in the assets that are backing loans)

The obstacles to scrapping the current system are a bit like the obstacles, say, to a peace process. Nobody willing to forget past (mis)deeds or make concessions on things that that they have fought for.

The problem is that people need to get into ridiculous debt simply to be able to get into a house of their own. There is a problem with property distribution, personally I think that if a person must pay taxes to the State, the least that they should receive in return is a decent place to live. If the State cannot provide that, it is owed no taxes.

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I think the straight debt jubilee idea is probably more than people could stomach, even if it did release the economy from it's shackles. I think it is a potential option, but it would be pretty unfair for anyone who has lived within their means. Like I said, if needs must, it could be an option, but I think we would have to be in a truly desperate state.

In terms of replacing credit with real money, there are ways and means to nudge towards it. For instance, we could use QE money to create a good bank, or even use Northern Rock as a vehicle to inject QE money straight into. They could floor the interest rates, tighten up the lending multiples and push mortgage holders towards the state owned bank. As QE is printed anyway, they could just set rates to the 0.5% base rate (which the general public assume they should be!) and set the multiples to 2x+1x or 3x (explaining this is for their own good). Once people are used to the idea that it is a national bank, telling the public that they are repaying the public owned debt with public money should (at least, could) be easy.

I mentioned this in another thread, as current UK banks have lent at an average of 33:1, providing state mortgages for all the £1 trillion or so of mortgage debt isn't too tall an order. Print up £30 billion in QE (or even just plain printing - why be coy?), put it in the state bank and I think all the bases are covered. Unless I'm missing something, the government will be just beating the banks at their own game. The difference is, they have the advantage of being able to add enough base money as they need, interest free.

Ok, adding £30 billion to the base capital (which was said to be between £50-75 billion before QE, I believe) now could be considered inflationary, it would pale into insignificance compared to the £125 billion of QE already about to cause massive increases in potential broad money anyway! The question I have is why did they push so much QE into the system to support the existing banks, when they could have created their own, with less potential for inflation too?

What you're talking about is essentially State lending, they wouldn't even need to use Northern Rock they could lend straight from the BOE or the Treasury. A State guarantee of mortgages amounts to the same thing. The obvious advantage of this is that the State would get any upside from the interest payments, or more accurately, it would deprive the private sector of this (unfair) advantage. The obvious problem is that the State would be even more ambivalent about the quality of the loans and the likelihood of them ever being paid back. Please note, debt does not cause inflation is there is an expectation that it will be paid back... which tells you a great deal about the quality of the UK commercial loan book.

Either way, we still come back to the problem of deposits being guaranteed by the State and not backed by anything. Even if we Nationalised the banks tomorrow, it doesn't change the fact that there is a mis-match between the quantity of bank IOUs and their ability to redeem them. But, yes State lending would solve the immediate "problem" of credit deflation.

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