Banking Crisis - Treasury Contents

Memorandum from Rev Dr Richard Rodgers, Leader, the Common Good Party

  1.  Thank you for working so hard to find a solution to the current financial crisis.

  2.  I would like to ask to make an oral submission to the committee. I realise that you have spent a great deal of time hearing evidence but I believe I have something important and lucid to say which has not been sufficiently drawn out by most of the people from whom you have heard. My contribution relates to a systemic problem with the banking system as it is currently organised which if not addressed will bias our economy towards recurrent disaster. Furthermore I believe that people with a professional connection to the crisis have an inherit bias against exposing this systemic defect either because they profit from it or they would be embarrassed to "declare that the Emperor has no clothes" and to risk looking foolish and damaging their reputation unless everyone saw the issues their way. They are reluctant to take that risk.

  3.  This submission touches on various terms of reference including 1.6, 1.8,1.9,1.12,1.13 and 2.1. I append a brief CV at its foot.

  4.  Executive summary: Banks create money out of nothing. The chief cause of the banking crisis is allowing commercial banks to create the non cash element (about 97%) of the money in our economy out of nothing by issuing loans of money that didn't exist until they lent it. It costs the banks virtually nothing but they stand to gain hugely from the repayments of capital and interest that borrowers have to go out and earn by the sweat of their brow. It is a bonanza for the banks. They enjoy an unfair advantage over the rest of us; as if we let them print bank notes freely in their back offices. If you or I did this we'd be locked up. They have no moral reason to be allowed this special privilege. They are just businessmen acting in their own interest. The central bank the Bank of England acting on behalf of the state in the interests of society should enjoy the sole authority to create money. Banks should be stopped from doing so. Every month the Bank of England should calculate how much money the nation's current level of economic activity requires and create it and give it to the government to introduce into circulation by spending it on the things the government usually spends money on. That way, no interest is payable by society as a whole just to have this money circulating as our means of exchange. At present we pay bankers for the privilege of using bank-loan money that they have created as our national currency. At present they have an incentive to create too much and to egg people on to borrow more and more or they had until the edifice collapsed recently. It's why so many people have been tempted into debt and why houses cost so much. The altruistic Bank of England would have no such pecuniary interest to create and issue too much money.

  5.  Banks also create money by the credit multiplier mechanism by which current account deposits are lent out to a series of other borrowers despite the risk that the depositor may come and ask for his money back at any time and that the bank is contractually obliged to give it to him. Most (100% minus the reserve fraction) of the original deposit is lent out as it passes through the hands of successive banks, several times over, creating more and more bank deposit money out of the original modest deposit. Depending on the reserve fraction in force the amount of loan money created can reach around ten times the amount of the original deposit, thus creating out of nothing a sum equivalent to around nine times that deposit.

  6.  The crucial question is "in whose ownership is money created"? At present in the UK money is almost all created in the ownership of the commercial banks when they make loans. The approximately 3% of our national money that is notes and coin is all that is created by the central bank on behalf of the government. I presume that some bank loans include an entirely legitimate element that comprises the deposits of the savings accounts of savers on the lines of old-fashioned mutual building societies, but, I gather that most is "magicked" into existence by sleight of hand by the banks. Money so created, when it enters circulation does so bearing interest that society has to repay to the banks as opposed to money created by the central bank as an agent of the state which would enter circulation debt-free (interest-free).

  7.  This sort of money creation activity by commercial banks gets little attention in the media. I think it is so breathtakingly audacious that speaking of it is embarrassing to men of stature in banking, journalism or politics. There is a tacit conspiracy of silence over it. I believe such activity does exist, however, since this construction makes sense of observable facts, whereas denying the possibility of such activity leaves us with a set of observations which baffle most people.

  8.  Over the last ten years or so the approximate 14% pa growth of M4 money supply has far outstripped to approximate 2% growth in GDP. I realise that this discrepancy is partly explicable by "open market" operations of the Bank of England and purchases of British real estate by foreign nationals. But even allowing for such factors it seems to me to show that someone is creating a lot of money that doesn't correspond to any real growth in the economy. I think a big part of the answer is this spurious "creation of money out of nothing" by banks.

  9.  The Daily Telegraph of 14th February 2007, quotes Steven Crawshaw the then Chief Executive of Bradford and Bingley Building Society as saying that a reduction of the Basel II reserve requirements was equivalent to the society having an extra £300m capital and would let it lend out an additional £12 to £15 billion without having to raise any more capital.

  10.  If B&B weren't having to raise any more capital where were they going to get the money from? My thesis is that they planned to get it out of thin air by what I would almost dare to call a trick with figures; and they were going to get away with it because most people get a bit muddled about these things. Subsequently, of course, B&B got into difficulties.

  11.  There are three problems with commercial banks creating our money supply out of nothing:

  12.  First, they have an incentive to lend too much. It costs them very little to create this money. It is not money they have obtained from anywhere but money they have written into existence in their accounts by a mere book-keeping entry. In the case, say of a house purchase, the money only comes into existence when the vendor banks the cheque written by the purchaser who has obtained permission from the loan-issuing bank to write such a cheque. I am told that in many cases, these days, that money didn't exist before this instant. It wasn't money obtained from savers or borrowed from another bank. It was just created.

  13.  Banks benefit greatly by this mechanism. I would almost call it a fiddle. It costs them nothing, or almost nothing, to issue this bank-credit-created money. On the other hand they stand to gain enormously as the borrower labours to repay both capital AND interest over the term of the mortgage.

  14.  This mechanism introduces a huge perverse incentive for banks to lend out this sort of money that they have created out of nothing in exchange for future repayment of the debt with earned money from the real economy and with interest that the bank demands to boot!

  15.  It's an absolute bonanza for the banks. They love it.

  16.  They are perfectly happy that most people are muddled about how the crisis has happened. They shelter in the obfuscation.

  17.  This "dodge" is so lucrative that it gives the banks an incentive to lend to many people. The more the merrier. Since it is money that didn't exist and since they are being paid back in real money, the more they can do it the richer they get.

  18.  This is why so many people have got into debt. Yes certainly many borrowers have been rash about taking out loans but the loan wouldn't have been on offer if the banks hadn't had a big incentive to lend it and "money for nothing" is this huge incentive.

  19.  That's why bankers get huge bonuses. To blame the banker is to miss the point. The point is that the incentive is there. The senior banker can see it and being a lively chap he uses to opportunity to the full and incentivises his subordinates to get borrowers to sign up.

  20.  The second problem is in whose ownership the money is being created.

  21.  In Britain today most money is created in the ownership of the banks and the banks issue it as a debt with interest payable on it.

  22.  So British society as a whole is having to pay interest to self-interested businessmen just to use money they have created as the currency of our land and we can never catch up. We have to borrow more and more just to pay the interest.

  23.  There is an alternative. We as a society could issue our own money that we as a society own outright rather than having to turn to businessmen and asking to use theirs. The banks are being allowed to print our money, basically. They are being given an unfair advantage over the rest of us. None of the rest of us is allowed to print money or create it by a computerised accounting entry as the banks do.

  24.  If they have been lending this fictitious money to home buyers, I suspect that they have also been lending money of similar dubious origin to hedge fund business people and derivatives traders for the purchase of whole companies on an even more massive scale; hence the large amount of money sloshing around the system.

  25.  The creation of money in our land must be brought within the domain of the state, with the Bank of England acting altruistically as a servant of the people and the right to issue money must be taken away from the banks.

  26.  Then the money created won't all have to have interest paid on it just because it exists.

  27.  After the current crisis, the public will be better served by banks remaining as commercial competitive institutions so they can compete to offer advantageous rates to savers and mortgage borrowers and to provide a cheap efficient payments system. It is better not to nationalise banks. It is just the creation of money ex nihilo that they should be stopped from doing.

  28.  How to proceed. Customers' deposits in current bank accounts must remain sacrosanct. They must remain the property of the customer even if he has to pay the bank a little to look after that money for him. He may also have to pay a little for the banks to operate the nation's payments mechanism. Banks, however, must not be free to dip into customers' current account deposits to lend them out when the depositor is not looking. This current account deposit money must not even enter the bank's books. Accounting would be totally separate from the bank's own money. It would be just like operating your own piggy bank or the safe deposit box at your holiday hotel. The depositor would be to only one touching the money. Then there would be no question of a run on a bank or of the bank losing current account depositors' money since they wouldn't have had access to it in the first place. Banks would howl a bit at the loss of income that honesty would involve but they would get over it and in a competitive market the safe-keeping and payments services might even improve.

  29.  Saving's account deposits would be different. Savers would actually take the step of deliberately handing over ownership of their funds to the bank in return for the bank's promise to pay it back at a later date with a share of the interest it has earned by being lent out to the bank's borrowers, as happens at the moment. That's fine. It's straightforward and it doesn't involve any of this mysterious money creation activity.

  30.  The change from the present system of bank created money to money created in public ownership by the central bank acting in the public interest, is do-able. The details need to be worked out by technicians but the decision to change to such a system is in the hand of the people, with our politicians acting as our agents.

  31.  The Prime Minister should include this topic on the agenda of the G20 summit in London of 2nd April since it would be best to make such a change as an entire international polity and we should lead the way on this. I am taking steps to get the other governments thinking along these lines also.

  32.  I have read around the subject and discussed it with bank officials, academics, seasoned monetary reformers and with members of the public. I believe I have understood the issues correctly even if I may lack the detail of experts. Nevertheless, many of the people who have lived with these issues for many years are too near them to see the wood for the trees.

  33.  We need a really lively, frank discussion of the issues from this perspective and I believe I could help the committee in such an endeavour. You have worked enormously hard to find answers. I respect this excellent example of diligent, careful parliamentary work. I firmly believe that this my insight is clear and pertinent and I would love to have the chance to meet you to pursue these issues further.

February 2009

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