Uk Monetary Reform

[Panda]

http://www.bankofenglandact.co.uk/how-it-works/

How will this effect holding cash/savings, then interest rates......................inflation?

P

[RufflesTheGuineaPig]

http://www.bankofenglandact.co.uk/how-it-works/How will this effect holding cash/savings, then interest rates......................inflation?

MCLs a their very best!

Lets look at the first paragraph!

To find a solution, you have to start by looking at the root of the problem. In this case the root of the problem is the creation of new money (as debt or credit) every time a loan is made.

So you are saying loans CREATE moeny?

As explained in the section before, this happens thanks to the fact that we permit banks to lend 92% of all the money that they receive from depositors

Wait so now your saying it's not money being creating, it's simply the lending of existing money!

whether the depositors actually wish for their money to be lent, or would have preferred for the money to be kept safe and away from risk.

If you put money in the bank you accept they are going to lend it out, it's why you get paid interest. If you want zero risk, you put it in a safety deposit box.

When this money is lent and returns to the banking system via other depositors, it is recorded as new money, and can then be used to fund yet more loans.

It's not new money, it's new DEPOSITS.

Basically the problem is that the only people who think private banks "create" money are the MCLs and even they can't explain how it happens without contradicting themselves.

The result is that the MCLs wander around sounding like they know what they are talking about and accidentally convince innumerate people who don't understand banking that private banks actually do "create" money... and then people get in a flap convinced that when they get a loan the bank just adds some zero to their account on a computer.

The net result is that it hides the true problem... that all these debts are created because of high house prices, and the big landlords and landowners end up with an increasing share of the money despite having done nothing productive.

Edited July 14, 2010 by TaxAbuserOfTheWeek

[Traktion]

I think they have a rather layman's message, but it is a message which is getting out to people - it has been linked several times here, on newspaper blogs and elsewhere too.

TBH though, I think their description of what currently happens is not close enough to reality. I happen to agree with the full reserve banking approach, but they are telling many none truths and confusing the issue in the process. As I posted up the other day:

1. Who is the national debt owed to? It's owed to holders of government debt - gilts. Many of these are institutional investors, such as pension funds, and wealthy individuals, who need somewhere to park their wealth. If the government refuses to pay back this debt, it is defaulting on payment to individuals, some (many, IIRC) of whom will be UK citizens.

2. If the government doesn't borrow what it can't raise in taxes, there would be no national debt in the first place. Borrowing more and more for decades, then complaining there is a large debt, is rather daft, really. Governments should be forced (by law and the will of the people) to live within their means and only spend what they tax - it would be far more honest and easier to elect the government you prefer too, whether high or low taxes and spending.

3. What is base money? When we talk about fiat, we're talking about what was the £60bn or so (IIRC). QE has muddied the waters, by many saying that this won't be repaid (I would agree) and that it has essentially swelled this figure to over £220bn. But what was backing that original £60bn? Originally, it would have been gold, but that backing has long been removed - it is now just pure fiat. We do still have gold reserves though, although I'm unsure how much this gives value to the fiat - IMO, it now has value, purely because it is in demand to pay for taxes.

4. Banks don't create money, they extend credit. Essentially, they're lending out a proportion of your money, along with everyone else's, while promising that you can access all of this money at any time. Without government backing (deposit guarantees, limited liability, lender of last resort etc), this is prone to bank runs, as occasional panics call the banks' bluff. Therefore, we ended up with government backing to prevent such panics, but now we have a problem with banks expecting to be bailed out - the 'too big to fails' - which means that the governments have to print up any money promised by the bankers, should they be unable to deliver it themselves. If the government doesn't print up the money, we risk falling into a credit deflation, people losing their savings, jobs etc, so the governments pony up the money.

5. Because of 4, people often say that the banks can control inflation, then blackmail the government to prevent deflation. I would agree and it's this cycle which needs to be broken. The best way is to switch to a full reserve banking system, such as Limited Purpose Banking (see sig), where people choose their own investments, along with their exposure to risk. No bank runs can occur and a liquid mutual fund market would reduce problems with maturity mismatching on timed savings.

6. In addition to 5, the government needs to stop borrowing, which is regressive as it feeds the wealthy with interest paid for by today's tax payers. Government borrowing is also dishonest, as unfunded spending can ensue, with subsequent governments being left to balance the books and pay down this debt (sound familiar?). Taxing in order to spend alone, in all but extreme circumstances, would go a long way to righting the system.

How to get from here to there? You enforce timed savings (preferably in mutual funds, like in LPB) for all but a proportion of on demand deposits. Dividing up bank reserves equally per capita (up to the amount on deposit) for on demand accounts would probably give most average people full reserve access to their money*. Money saved beyond this amount would be placed into timed savings accounts (where you don't have instant access), from choices presented to the saver at the time. As bank reserves would be unchanged, with the same amount on loan now being matched by timed savings (preferably, risk bearing, as in LPB), net credit would remain the same, but a proportion beyond instant access savings would be inaccessible (and at risk, ideally**). Everyone would then know where they stand and no one would be promised money which may not be accessible.

The national debt should then be gradually repaid, as anything else would arguably be dishonest/unfair. Defaulting on debt, even if you think the debt shouldn't have been run up, is still a default and some people with lose out. Perhaps a partial default in the aim of 'fairness' would be bargained for, but it is a very subjective solution.

In summary, there is a better way of solving the problem of distributing capital, which does not reward the bankers, nor risk taxpayer money. There just needs to be the political will to understand and attend to the problem, rather than continue on with the same flawed system.

* 220,000,000,000÷60,000,000 (total fiat ÷ population) => rough fag packet amount of up to about £4k per capita for on demand deposits.

** All investments carry risk and should be reflected on the individual making the investment - or interest bearing savings.

(http://www.housepricecrash.co.uk/forum/index.php?showtopic=146738&st=15)

In summary, I think their heart is in the right place and I think the message is reaching plenty of people. However, I don't think it defines the problem or proposes a good solution.

[Timak]

Basically the problem is that the only people who think private banks "create" money are the MCLs and even they can't explain how it happens without contradicting themselves.

The result is that the MCLs wander around sounding like they know what they are talking about and accidentally convince innumerate people who don't understand banking that private banks actually do "create" money... and then people get in a flap convinced that when they get a loan the bank just adds some zero to their account on a computer.

Not sure I understand.

If I go to a bank and borrow £10m the bank do not have £10m, but if they do have £1m on deposit they can lend me £10m.

They do that on the basis that the £10m will eventually be depostited in the banking system.

Where does the new £9m come from?

[LittleSteroid]

Not sure I understand.

If I go to a bank and borrow £10m the bank do not have £10m, but if they do have £1m on deposit they can lend me £10m.

They do that on the basis that the £10m will eventually be depostited in the banking system.

Where does the new £9m come from?

yes, its called : fractional-reserve banking and that is what causes INFLATION MYSTERY OF BANKING

Edited July 14, 2010 by LittleSteroid

[Timak]

yes, its called : fractional-reserve banking and that is what causes INFLATION                                                                                                                                            

Sorry I was trying to understand what the previous poster meant by

"The result is that the MCLs wander around sounding like they know what they are talking about and accidentally convince innumerate people who don't understand banking that private banks actually do "create" money... and then people get in a flap convinced that when they get a loan the bank just adds some zero to their account on a computer."

I just wasn't sure where the money came from if it wasn't just the bank "creating" the money.

[Traktion]

Sorry I was trying to understand what the previous poster meant by

"The result is that the MCLs wander around sounding like they know what they are talking about and accidentally convince innumerate people who don't understand banking that private banks actually do "create" money... and then people get in a flap convinced that when they get a loan the bank just adds some zero to their account on a computer."

I just wasn't sure where the money came from if it wasn't just the bank "creating" the money.

Like I said above, they're not being entirely honest with their terminology, but then it isn't helped when credit is interchanged with money in other places too. M4 is called 'broad money' when the majority of it is bank credit (M4-M0=bank credit, I believe, where M0 is base money), for instance.

Banks can only extend credit, but as soon as the banks liquidity is tested (ie. they have more withdrawals than they have reserves), then the government and/or BoE steps in to ensure that they have enough reserves to cover the current demand for withdrawals. In this way, the bank only extends credit, but the state is blackmailed into printing up money to cover the bank's liabilities, if they have come up short - failure to do so threatens a deflationary collapse, as so much credit has been extended.

With full reserve banking, instead of the bank promising that the depositor can have full access to their money, at any time, you have timed savings. Timed savings are not instant access, as once the money is out on loan, it is in some one else's account - two people can't have the same claim on the money, so this is logical.

The bit that seems to confuse people, is that if fractional reserve has a 10% reserve ratio (and are at max. lending capacity), this is the same as people having 90% of their money in timed savings, in terms of total credit. The only difference is that full reserve banking doesn't promise to give access to this 90% at any time, where as fractional reserve banking does. Clearly, this promise can not always be kept, which is why we have bank failures/runs. This is why M4 is a bit of a nonsense - it is just a measure of leverage of M0 (base money). With full reserve, only M0 is useful, as M4-M0 is in timed savings and is not counted twice.

However, in the good times, it makes no difference* whether that 90% available for lending is in timed savings or in fractional reserve savings. It's only when loans start to go bad that the reserves start to get eaten up and then we have liquidity (and possibly insolvency) problems. With full reserve, your 10% would still be safe, but the 90% may not be returned in full** in bad times.

*In terms of total credit - there would of course be a different mechanism for distributing the funds.

**Using a full reserve model like LPB, all borrowing/saving are mutual fund shares, which could be traded on the open market, but can't be liquidated until maturity. In this sense, all investors take a proportional hit if losses occur. If you needed access to the money before maturity, then you would trade the mutual fund shares on an open market. Liquid mutual fund markets would therefore provide maturity transformation services.

Edited July 14, 2010 by Traktion

[Timak]

Like I said above, they're not being entirely honest with their terminology, but then it isn't helped when credit is interchanged with money in other places too. M4 is called 'broad money' when the majority of it is bank credit (M4-M0=bank credit, I believe, where M0 is base money), for instance.

Thanks for the explanation.

It is something that, on the surface is very persuasive, I just wanted more opinions as to whether what they were saying is true and if a solution as elegant as they suggest is possible.

Because if it is that simple it would be amazing if it weren't done

[Harry Sacks]

MCLs a their very best!

Lets look at the first paragraph!

So you are saying loans CREATE moeny?

Wait so now your saying it's not money being creating, it's simply the lending of existing money!

If you put money in the bank you accept they are going to lend it out, it's why you get paid interest. If you want zero risk, you put it in a safety deposit box.

It's not new money, it's new DEPOSITS.

Basically the problem is that the only people who think private banks "create" money are the MCLs and even they can't explain how it happens without contradicting themselves.

The result is that the MCLs wander around sounding like they know what they are talking about and accidentally convince innumerate people who don't understand banking that private banks actually do "create" money... and then people get in a flap convinced that when they get a loan the bank just adds some zero to their account on a computer.

The net result is that it hides the true problem... that all these debts are created because of high house prices, and the big landlords and landowners end up with an increasing share of the money despite having done nothing productive.

Yeah right. And house prices triple in ten years because 70% of M4 is attributed to mortgage (credit) creation.

"The net result is that it hides the true problem... that all these debts are created because of high house prices..."

You don't get high house prices unless the money is created in sufficient quantity for prices to increase. As the majority of new money is created against property (secured lending) this is the conduit for new money creation.

[duckwomanloulou]

yes, its called : fractional-fictional reserve banking and that is what causes INFLATION (corrected for you)

Edited July 14, 2010 by duckwomanloulou

[spanman]

http://www.bankofenglandact.co.uk/how-it-works/

How will this effect holding cash/savings, then interest rates......................inflation?

P

Affect - sorry pedant

[Traktion]

Thanks for the explanation.

It is something that, on the surface is very persuasive, I just wanted more opinions as to whether what they were saying is true and if a solution as elegant as they suggest is possible.

Because if it is that simple it would be amazing if it weren't done

I don't think what they are proposing is the best solution, but at least they are opening the debate and reaching an audience. It is just very easy to say that banks create money from thin air, expecting gasps from the gallery. It's much more complicated than they make out, but it is a good way to explain the situation in layman's terms.

Also, I don't like they way they seem to allude to the BoE printing money for investment projects. I don't trust the government to do this. If they wanted to change the money supply along with population (or a growth metric of sorts, perhaps?), then a national dividend could be paid to everyone when there was growth, with the opposite (more tax than is spent in a fiscal year) taking place in reverse. Essentially, it could be policy beyond the government's remit, which they would not be involved with. It can't be worse than constant deficit borrowing, to meet some arbitrary inflation target, either way.

[Um_Bongo]

Not sure I understand.

If I go to a bank and borrow £10m the bank do not have £10m, but if they do have £1m on deposit they can lend me £10m.

They do that on the basis that the £10m will eventually be depostited in the banking system.

Where does the new £9m come from?

If the bank have £1m they can lend out %90 of it and keep %10 as a fractional reserve. They cannot lend out £10m.

[Traktion]

If the bank have £1m they can lend out %90 of it and keep %10 as a fractional reserve. They cannot lend out £10m.

In vanilla fractional reserve banking, that is only the first part of the picture. If a bank has £1m, then lend out £900k, the borrower deposits that £900k in their account. The bank then takes that £900k and lends out £810k. Rinse and repeat until there is about £9m out on loan, with only £1m base money. In this case, M0 would be £1m and M4 would be £10m+ (the plus being other financial promises).

With modern banking, they can also extend credit for mortgages out of nothing. As they are extending credit against the price of an asset worth the same amount, the books still balance. Then we wonder why house prices have spiralled out of control...

The problem is, there is still only the same amount of base money. If those with savings in the bank decide that they no longer trust it and start withdrawing their money, their reserves will be tested - the bank would then be having a liquidity crisis. When a bank only has 3% reserves, there are going to be a lot of people unable to get their money out*, which is why the government is compelled to bail them out.

Back when fractional reserve banking was being talked up, it was said there needed to be an elastic money supply. Clearly, we now just stretch the elastic until it snaps, then give the banks another piece of elastic! The banks now dictate the money supply by extending more and more credit - the more credit, the more profit - then socialise any losses.

* The bank will have lots of illiquid assets, which would take time to liquidate/sell on to other banks. An insolvent bank will be unable to cover its liabilities, even if given time to liquidate. If this happens to lots of banks at the same time, all the assets will depreciate in price, creating a downward spiral, with more banks becoming insolvent.

Edited July 14, 2010 by Traktion

[Um_Bongo]

In vanilla fractional reserve banking, that is only the first part of the picture. If a bank has £1m, then lend out £900k, the borrower deposits that £900k in their account. The bank then takes that £900k and lends out £810k. Rinse and repeat until there is about £9m out on loan, with only £1m base money. In this case, M0 would be £1m and M4 would be £10m+ (the plus being other financial promises).

There's nothing peculiar to a bank here. Anyone can do the above by acting as a borrower/lender - rewrite the above but replace bank with 'Dad' and the other parties as 'Son'/'Daughter'.

There may be a loan book with a £10m total on it but it all balances out with the deposits that created the ability to loan out in the first place. There is NOT £10m floating around the economy - in fact the vast majority of the money is on deposit at the bank and the bank will not be able to lend out any more unless they bring new money in.

With modern banking, they can also extend credit for mortgages out of nothing. As they are extending credit against the price of an asset worth the same amount, the books still balance. Then we wonder why house prices have spiralled out of control...

They are extending credit from the liabilities they have on book. If this was not the case then there would be no funding problem.

[Harry Sacks]

There's nothing peculiar to a bank here. Anyone can do the above by acting as a borrower/lender - rewrite the above but replace bank with 'Dad' and the other parties as 'Son'/'Daughter'.

There may be a loan book with a £10m total on it but it all balances out with the deposits that created the ability to loan out in the first place. There is NOT £10m floating around the economy - in fact the vast majority of the money is on deposit at the bank and the bank will not be able to lend out any more unless they bring new money in.

They are extending credit from the liabilities they have on book. If this was not the case then there would be no funding problem.

I suppose inflation doesn't exist either?

[RufflesTheGuineaPig]

Not sure I understand.

If I go to a bank and borrow £10m the bank do not have £10m, but if they do have £1m on deposit they can lend me £10m.

They do that on the basis that the £10m will eventually be depostited in the banking system.

Where does the new £9m come from?

At first I thought you were trying to be ironic.

If the bank has £1m, they can't lend you £10m, they can only lend you £900,000.

If they want to lend you £10m, they have to borrow £10m from another bank, hedge fund, pension fund or similar.

What they can also do is lend you £900,000, then sell that debt (usually packages along with lot of other debts) on to another bank, or a hedge fund etc. then lend the money they get from selling the debt to someone else.

At no point is any "money" created. A tradable asset (the packaged loans) is created and exchanged for existing money.

The reason house prices (and the amount of moeny spent on them) can go so high without the creation of additional money, is due to the number of times the money can do round the deposit-lend-deposit loop before the amount that needs to be kept in reserve get to high.

Those reserve level got high in 2005, so the rules were changed to simply lower the reserve level so the money could go round the loop again a few more times.

[Um_Bongo]

I suppose inflation doesn't exist either?

Not in this simple system, however if i add in a central bank then the world is your oyster....

[LittleSteroid]

yes, its called : fractional-fictional reserve banking and that is what causes INFLATION (corrected for you)                                                                                                                                                                                         

well, u r right actually

[Charlie The Tramp Returns]

From my Thread pinned in The Off Topic Forum

The Banks hold over £1 Trillion of savers money in accounts.

The Fractional Reserve Banking System

The privately owned high street banks do not lend out their saver's deposits as loans to those customers who wish to borrow. They never have. Instead these deposits act as a reserve on any calls that banks have on their money over and above the normal in-flow of funds. It is called their fractional reserve.

Instead of lending actual cash money to borrowers, the banks have only ever lent 'credit'. However, this credit is used by individuals to buy homes and to spend through their credit cards, overdraft facilities and arranged loans. It is also used to run businesses, to pay employees and suppliers, who further use it to run their own finances. Governments borrow it for public spending when income from taxation is insufficient.

This bank-created credit now forms some 97% of the British money supply (with similar ratios affecting all the world's major economies), and it has effectively become money. If a person borrows, say, £100,000 from a bank to buy a house, they regard that sum as money. It gets paid into the vendor's own bank account and they also regard it as money and spend it as money.

The amount of credit lent as a proportion of money held on deposit has always been a matter for nice judgement by the individual banks. The more they lend the more profit they make, but the more exposed they become, if too many customers want their money back in the short term. During the 18th and 19th centuries, private banks often collapsed due to a 'run on the bank'. Nowadays, the banking system as a whole tends to rally round to prevent any one bank collapsing, if only because they are all so bound up with each other.

So by the 20th century a figure of 15% was established as a suitably 'safe' exposure - the prudent fractional reserve. This meant that for every £100 that a bank had out on loan, it had £15 of savings held on deposit to cover the loan. This was the equivalent of a bank lending out each of its saver's deposits six times over. This was a fabulously profitable way of working, but it did at least impose a degree of constraint upon bank lending.

Bank de-regulation in the 1980s and the decline of the use of cash has ended even this modest constraint.

No Reserve

The use of cash has declined from 46% of the money supply in 1946, to 21% in 1972 and now down to 3% today, making this 15% 'safety' figure cease to have relevance. A reduction of cash to just 3% of the money supply suggests that the 'fractional reserve' of most banks has also fallen to a similarly low level. In other words, banks can and do lend to the amount of over 30 times their depositors' savings. To all intents and purposes, with such a tiny amount of reserve required and as cash is now so little used, there is virtually no restraint upon the amounts that banks may lend.

There certainly is no government control upon bank lending. The only influence by statutory authority is an increase in base interest rates by the Bank of England's Monetary Policy Committee when inflation rises, indicating too much money within the economy.

In recent years, despite the growth in the money supply, both interests rates and inflation have been at a very low level. This may be because, despite there being so much money in circulation, a large proportion is in use simply to pay the interest on the high level's of borrowing. It is therefore not available, as historically it would have been, to allow high levels of inflation to occur with 'too much money chasing too few goods'.

Bad Debts Rising

This natural curb on both inflation and interest rates, caused by the straight-jacket of high levels of borrowing, should not allow us to be complacent, however. The level of bad debts is rising steadily. At the time of writing it is estimated to be in the region of 20%. In other words, the banks are losing about £20 for every £100 they lend.

Given that the money that they lent was created out of thin air in the first place, it is money that they can afford to lose. It just means that their profits are a few billion pounds less each year than they would otherwise have been.

For the individual borrowers concerned, however, this difficulty with indebtedness is not so easily dismissed, for the banks do not allow them to walk away from their commitments without difficulty. Homes are repossessed; businesses go bankrupt; county court judgements are imposed; debt-collectors are set onto people; sleepless nights become common; marriages break-down; spouses and children become the subjects of physical and emotional abuse; suicide is contemplated and even attempted.

All this is because the culture of thrift has been swept a away in an orgy of irresponsible lending. Everywhere, lenders are falling over themselves to push borrowing down people's throats. People are urged to sign loan agreements that they do not understand, proffered by people whom they do not know, to borrow money that they cannot afford, to buy things that they do not need.

A Topsy-Turvy System

We have the most topsy-turvy credit rating system, wherein people with large amounts of debt are given good credit ratings and permitted to borrow more, whereas those who have a history of prudence, who have scarce ever borrowed before are given poor ratings and are penalised by high rates of interest!

This cavalier attitude on the part of the banks would be entirely curbed by the simple expedient of making it illegal for them to create money. Then they would have to very careful with the money that they lent out, as it would not have been created out of thin air. They could fulfil a useful and profitable role within the economy, but it would end their capacity to lend irresponsibly.