If You Support Private Banking You Support Government Subsidized Banking

There are lots of contradictions in the world of finance and economics about “free market capitalism” and the persistent attacks against “banksters”.   But there are a few simple truths that we should all agree on before we go railing against the system as it presently exists:

1)  Our monetary system is designed primarily around private banks who distribute money within a market based system. Banks create loans which create deposits (money) when creditworthy customers have demand for loans.

2)  Our government has outsourced control of the money supply to the private banking system.  The government doesn’t actually create much of the money at all.  The banking system handles most of that.  The government mostly just regulates and facilitates the smooth functioning of the money system.

3)  Private banks don’t work for the government.  They work for their shareholders just as all privately owned companies do.  In doing so, they are under pressure to maximize profits and at times, take big risks to expand their businesses and meet the growing needs of their shareholders.

4)  Just like any other capitalist entity, there is an inherent instability in the model that is private banking.  That is, banks are susceptible to irrational and even ignorant business transactions which result in volatility in their businesses as they pursue profit maximization.  In other words, banks are not immune to the business cycle.

5)  Banks, however, are unique, in that their failures can have massively damaging impacts on the economy since banks dominate the payment system which greases the wheels that keeps the economy running smoothly.  So, when the wheels fall off the banking system, there are times when it needs exogenous support or it risks unnecessarily bring down the rest of the economy.

6)  That exogenous support comes from the government who has the incredibly powerful tool of taxation.

7)  Banks are constantly receiving massive government support (via the Fed or the government) via massive fiscal transfers that amount to trillions in government subsidies.  The banking system is so crucial to the health of the economy that it can really be no other way.  And yes, we’ve tried rogue capitalist banking before where there was no government support.  It didn’t work out all that well as we discovered during the many panics of the late 1800’s and early 1900’s.  Depressions sound cool until you spend half your life in one….To a pure capitalist, this free market system is better than just having the government issue all the money.  To a pure statist, the capitalists abuse this system and should be stripped of their power to issue money.

Of course, we could qualify all of this by going all Rothbardian on the banks and stating that they should be allowed to fail just like any other entity, but that’s not always a realistic outcome.  For instance, it’s now clear that the bank bailouts in 2008 actually stabilized the economy to a large degree.  Had we not done that, we likely would have seen an economic downturn that much more closely related to the Great Depression.  Ijn other words, all of us would have been sucked into a depression that was largely the result of a weaker banking system.  Would that have been necessary?  I say no.  And yes, I know that some will claim that would have been a “cleansing” of some sort, but that doesn’t mean the downturn wouldn’t have been much longer and deeper (or unnecessary).  Depressions are nice in theory, but it’s easy for us to all claim they’re good for the economy in the long-run until we’ve lived through one in the short-run….

In other words, if you support private banking and the system we have then you support bank bailouts at times.   Is that a good thing or a bad thing?  Is private banking better than public banking?  I am not here to play judge and jury, but only to describe what is.  What’s your opinion?

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • SS

    Most people are just ranting about their policy views without realizing that they’re mostly contradicting themselves.

  • Tyler

    I think a large part of the hate toward banksters comes from the fact that the major banks can do just about anything they want. If they break a law, it’s nothing a little fee can’t solve. Then something like Libor surfaces and completely demoralizes any hope for a fair financial system.

  • Effem

    I have no issue with government support of the banking system. However, the government should own a large chunk of banking equity and there should be limits on compensation in banking. It doesn’t take a genius to create money (make loans).

  • Dennis

    The banks are fighting hard with misinformation and scares about the student loan program. They want a big piece of the profits and don’t want the status quo to end. This could be a great fix: http://www.warren.senate.gov/documents/BankonStudentsFactSheet.pdf
    I think MR could explain why this would be a great change in the law and cause no problems at all.

  • D

    Yep, great points here and something I’ve grappled with for a while now. I always think of the banking system as an extension of the central bank and thus part of the government. Being mad at the banks is essentially being mad at the government. The bank’s power to “print money” via loan creation is a right bestowed by the government and can thus be taken away, albeit with consequences.

    Ultimately, the bailouts and subsidies for the banking sector is the government’s decision to trade unknown risks for known ones. For example, the government has no idea how bad things can get if it allowed big banks to fail and did not want to know. It rather deal with the moral hazard, which of course the government dislikes, than trying to manage a catastrophic collapse of the status quo. As long as society is ok with that, then who am I to argue.

  • LVG

    Nice clean explanation. Thanks. It drives me crazy when I see people complaining about banks and banksters while also claiming to be capitalists.

  • Widgetmaker

    Government is always and everywhere the problem. That is the convenient world view for so many people, and its a lazy man’s way of coming to terms with reality. That thought alone resolves so many of life’s conundrums and gives people an easy target to vent their anger. It is wrong, but it sure is a comfortable way to look at things.

    The difficult question is how much and where to impose governance. People seem to be aware of government only when it gets in their way, which it invariably does. The good that it creates is largely invisible. Try going through life a few years without a police department, fire department, or bank regulators and see how it suits you.

  • GLG34

    It seems to me that there’s an inherent conflict between the monetary system we have and the actual purposes it should serve. The banks don’t do anything that a public utility couldn’t do. In fact, some banks like the bank of North Dakota actually do it much more efficiently than private banks. I am no socialist, but I am not against state banking. In fact, I think it might be a superior option.

    But Americans are so closed minded about using the government for anything that it will never happen. And until we realize that it’s a viable option we’ll continue to have to subsidize the bank accounts of private bank owners.

  • Hofta

    Good post.

    Still I believe the stock and bond holders should have been wiped out. I also do believe that no institution pose any systemic risk, hence to big to fail is a myth. However, that drepends on the government taking over the institutions. As Minsky pointed out, at some point the CB must step in during a panic otherwise everybody will go down. This is not a contradiction, just that the Government/CB should not announce in advance which institutions to save and not to save during a crisis. The saved institutions can then buy assets at distressed prices with money borrowed cheap from the government.

    My point is that the Fed could have taken several other paths in saving the economy, and in my opinion they should choosen one without so much injust distortions in wealth distrubution.

  • InvestorX

    A strawman Argument. Banks can be kept operating and “greasing the wheels that keep the economy running smoothly” without being bailed-out or subsidized. All you Need is to apply the Swedish model, e.g. wipe-out shareholders and make bondholders take a haircut.

    What you are describing is a fascistic construct.

    Besides FRL is a legalized fraud. It is not given that FRL should be allowed and it is the only and best way to do Banking. If you allow FRL, at least you should make sure it does not get overextended and the Banks not overlevered. And if you are going to subsidize it, you should even regulate it more closely – e.g. like the safety Standards of cars nowadays, which do not prohibit private competition.

  • http://orcamgroup.com Cullen Roche

    Even the Swedish model still involves subsidies so that doesn’t really fix anything.

    Regulating more closely also won’t eliminate the need for subsidies. It might reduce it, but that’s about it.

    You’re not being very realistic. You’re just getting emotional.

  • jt26

    Lots of areas get government subsidies (big infrastructure projects, education, R&D, public transport…). We shouldn’t automatically assume that the subsidy is the first backstop, but rather regulation should be. Subsidies should be rationed for when there no fully private solution is possible.

  • InvestorX

    This Banking System is not capitalistic, but fascistic / oligarchic / crony capitalistic etc. Now hopefully you go nuts.

  • http://coppolacomment.blogspot.co.uk Frances Coppola

    I (reluctantly) found myself arguing in favour of nationalisation of core banking functions recently….since the economy is so very dependent on payment services, and on basic lending and deposit-taking, and banks cannot really do these profitably without taking risks that we consider unacceptable because of our dependence on them. That doesn’t mean that all forms of banking should be state-owned, though. I’m still working on a model which could combine state-owned utility elements with diverse private sector providers. The UK’s traditional two-tier banking system rather lends itself to this, though we’ve lost huge amounts of our second tier in recent years. But the model needs to be different in different countries – one size doesn’t fit all where banking systems are concerned.

  • InvestorX

    Look I do not mind subsidies, if on the other Hand I know that they cannot overlever and blow themselves up and thus their salaries and bonuses will be normal and their political influence is average etc.

    But subsidies for nothing on the other end does not work for me.

    What are the subsidies in Swedish model you are talking about?

  • LVG

    Who do you think pays for those regulators? You didn’t think they were free did you? You’re either subsidizing banks by having to regulate them or by having to support them when they collapse. Just because you don’t see the bailout fund being formed doesn’t mean that it’s not perpetually there.

    You don’t seem to understand that private banking is basically one big perpetual bailout. The government is always slipping the bankers a dollar here and a dollar there so they can keep the machine well oiled (or so we think).

  • http://orcamgroup.com Cullen Roche

    There are tons of subsidies. The govt is a massive payer of fees and commissions into the banking system in numerous different ways. We hire banks to run our bond auctions, make markets for the Fed, etc, etc. Regulation is a different form of taxation, which I am personally all for, but I also know it won’t entirely solve the problem of too big to fail or instability in banking….

  • DanH

    There are risks in not having the government issue all the money. By choosing to have the market decide how money is distributed we face the potential risk that they won’t do a very good job of it. To me, that’s worth it because I don’t want the government choose how all the money gets distributed.

  • JanVerR

    There’s no chance we’ll ever see public banking in the USA. It hasn’t even come to Europe in any meaningful way and we’re far more socialist than you all are.

    I personally believe the private banking system is a big leach that lines the pockets of the elites and takes advantage of the weakness of the poor by forcing them to use money with interest. It needn’t be that way.

  • krb

    Cullen,

    Suggesting that if we want private banking and stable economies we therefore must accept govt backstopping and subsidies for those banks is the same false choice presented to us by the bank centric govt leaders at the peak of the crisis.

    There are other ways to achieve the goals….

    “Banks” should be defined as those institutions that lend and hold deposits (plus related customer services like ATMs), and should be regulated like boring utilities…..banking is in fact boring when done as it is defined.

    “Shadow Banks”, that wish to participate in other speculative activity are NOT therefore “banks”. Banks wanted glass steagall removed in the late ’90s because shadow banks had profit opportunities not available to banks……duh!, that’s why they weren’t called “banks”!!

    Once the line between utility “banks” and speculative “shadow banks” was crossed, with govt backstopping of “banks” generally still in place, a speculative, gambling, moral hazard meltdown wasn’t just possible, it was inevitable!

    Due diligence of the soundness of counter-parties has become obsolete…it is easier to call on bailouts from govt and insurance products in case of default. This needs to change, and in fact can be changed…..just 3 legislative changes would be required to make substantial progress…..

    1. Lending and holding of deposits, ONLY, must define “banking”, and it is only businesses that practice only these two things that are eligible for govt support. Any business that currently practices BOTH banking AND other non-bank speculative activity MUST be broken apart. Allowing them the option of doing both and “waiving” their bank govt support will inevitably lead to a meltdown that requires govt stepping in anyway, in order to avoid a systemic collapse of the economy…..a repeat of 2008.
    2. The non-bank speculating, trading, etc. businesses formerly called shadow banks would get NO govt backstopping.
    3. Any non-bank executive pay gained during years of speculation that later lead to financial collapse by the business would be CLAWED BACK……greed and fear will never be eliminated from human nature…..laws and incentives must be defined so that greed works FOR good practices and not against them.

    These 3 steps would revive counter party due diligence OVERNIGHT, and lead to a more stable, and fair, banking and non-banking business environment and economy.

    You can’t just skip over the inept governance that lead to a commingling of traditional banking and speculative activity, as well as the inept oversight of those entities during the lead up to the crisis by Geithner and Bernanke, and then tell us that “private banking”, AS IT IS DEFINED TODAY, “must get govt backstopping whether it is popular or not”……what passes for “banking” today is no more banking than our economy is free market or capitalist. That’s like doing a bank robbery investigation without looking at anything prior to the get-away car!

  • The Dork of Cork.

    ” Private banks don’t work for the government. They work for their shareholders just as all privately owned companies do. In doing so, they are under pressure to maximize profits and at times, take big risks to expand their businesses and meet the growing needs of their shareholders.”

    Its more then that.
    They gain ultimate political power via the money supply.

    In the case of Ireland or Iceland for example the banking deposits could have become national equity money and the mortgages ,car loans etc declared null and void .

    Why not ?
    Oh yes…….you need pointless credit “growth” to pay interest on the national debt.

  • midas2

    I agree with Effem, taxpayers (via Gov.) bailout banks and should in fair return own proportionate shares in the bank. The unfair very generous incomes of the bankers, despite their dubious job performance, is not sensible.

  • midas2

    The European Union has just agreed to have shareholders take the loss before the CB lends support.

  • http://jerrykhachoyan.com Jerry Khachoyan (@TheArmoTrader)

    2 questions

    1) Is there a way to let banks fail, yet not make the recession (depression?) worse? Would there be some mechanism/temporary solution until the “market” is cleared and the (new or old) banks that are stable take over operations/etc.

    2) If not, is there a way to bail them out, yet not have the “moral hazards” that come with it? What would we do?

  • Amiami

    Dear Cullen,

    IMHO, everyone understands that banks are essential to the system in the way they control money and that they provide loans to the private sector !
    Anybody who understands the monetary system (that you have described quite accurately on your site) knows that.
    But not everyone agrees that banks should be allowed to play in markets and be bailed out when they lose.

    Here in London a “bankster” is not your banker who approves your credit and grants you a loan for your new car.

    He is your typical 26 year old trader with a degree in statistics who argues that the model in his derivatives position will make him money whether the market tanks, rises or even re-correlates to the benchmark ! And then asks to be paid 7 to 10 times your average salary.

    Or the sleek guy in a suit who has never managed a fruit stands in his life and tells the management of a super high-tech biotechnological company that they should buy in China and appoint him to make the deal because he has the “expertise”.

    Or the analysts that has been wrong 50% of the time (a proven fact) in their stock predictions, in other words he is no better than just tossing a coin.

    Or the private banker who manages some estate and ends up going 40-60 in stocks and bonds by buying in-house funds that are just glorified index ETFs but charges 3%.

    Same would hold for the guy who acts like he knows because he has a level 3 CFA and calls himself a fund-manager, has beaten the index in 2009 but lags it over a 10 year period…

    etc…

    In other words the people in finance that are not essential but pretend to be, the middle-men, leeches, parasites that are populating the system, feeding of it.
    Those are the “banksters” we should…bash.

    So as long as banks stick to what they have always done and should only do and that is lend money and leave speculation to hedge funds or partner-based financial firms, we won’t have a problem…

  • http://brown-blog-5.blogspot.com/ Tom Brown

    One idea I’ve seen is to break them up into smaller banks. There are a lot of arguments against this, but I don’t know if i buy them. The proponents of breaking up the large banks argue that if banks were smaller, then some could fail w/o bringing the whole system down. It seems to me there’s some evidence for this and for the idea that the government regulators would be much more willing to bring the hammer down on wayward SMALL banks (while they seem completely unwilling to do that will large banks). Willing regulators might actually add some consequences to bad bank and bank management behavior in the first place.

  • kd

    I like the Positive Money setup. Bank investment failure does not effect the payment system. One simply switches banks.

  • Dennis

    I have typed many times on PragCap that the private banks could be nationalized, and that would be better. But I’m not so sure now but: I think instead, Uncle Sam should be allowed to create it’s own bank right beside the private banks. The reason they need to exist is to further loans that the banks and non-banks don’t want to bother with UNLESS Uncle Sam backstops those loans. Then it’s a no-brainer for them. They can loan with the full assurance from Uncle Sam that the principal and interest will be forthcoming. If the taxpayer money is guaranteeing the loans then the bank SHOULD BE a US public bank.

    Example: The Student Loan program (one of the most important issues on the table at this time), was suppose to help higher education. Most of the Federal Funds for higher education were via grants for projects (NIH, NCI, and NSF, Defense Department). As a result, the private big name Universities were getting most of the money and your local college and Jr. college were not. So providing funds to the students, via low interest loans, was a way for the students to decide which school was best for them. Great, Fantastic Idea. But then the banks wanted into this….

    This could have been a very fair aid-to-higher education in the USA. What is more important to our economy??? But no, the banks had to get involved. So now we see what happens when private banks, that only answer to the bank’s president and the stockholders, mess things up again. This time for even more $trillions. This was suppose to be Federal Aid to Higher Education, and all we get is problems, now HUGE problems.

    OK, I’m not for bank nationalization. I’m for a US bank that can give loans backed by Uncle Sam, and NO other bank in the USA can give a taxpayer backed loan.

  • Steve w

    After the 2007-2008 financial crisis, there were calls to bring back Glass Steagal (sp?). The idea that banks should just stick to basic banking functions and be more easily (perhaps) regulated — like utilities — has a certain appeal.

    I don’t know much about the state owned North Dakota Bank, but find that idea interesting, if only at the state level.

  • Stephen

    Indeed, and also explains why Bitcoin for example will either have to adapt ,or die. Probably the latter. Adapt means it must find a place of acceptance within the established system whereby the originators of the system are allowed to partake in the transactional outcomes achieved by the use of Bitcoin. If that does not happen then the system controllers will destroy Bitcoin without any doubt at all.

  • Charles Fasola

    Well, then let’s have the banks and all private sector corporations operate completely on their own without the massive public support they enjoy. Instead of the current system of having their cake and eating it too. How about they pay for and maintain every single bit of infrastructure they use to facilitate their operations; rather than acting as leeches upon the public sector. they can build their own highways, airports, educate their own workforces, clean-ups of environmental disasters, all sorts of pollution. The list could become very substantial. The big old, bad, inefficient public sector would contribute nothing except the same police protections, that’s protections only, of their individual bodies and property. Oh you snort, prices will rise for everyone! Then those organizations that create ways to do it less expensively will prevail and the others join the scrap heap of history. You so-called free market capitalist supporters make me sick.

  • socal

    no, that’s not the view of lazy men, it’s the view of free men. sounds like the system has been working for you but for many it’s not… if you believe in violence, force, fraud and coercion, then gov’t is the answer. let’s evolve, not devolve.

  • socal

    btw, santiago, chile has an all volunteer fire dept. works just fine. we’re mature adults, aren’t we? we can figure out how to organize, educate, put out fires, hire security, trade freely and privately with whatever we choose to use as payment. the internet btw also makes huge swathes of gov’t functions obsolete. lol at needing bank regulators.

  • socal

    not sure how you can’t be outraged at what the banks are doing. you can’t honestly think doing things the way we’re doing is going to end well? 50 million on food stamps can’t be good. whatever you’re smoking, give me some.

  • Shorehaven

    Bring back Glass-Steagall.

  • InvestorX

    Agree completely.

    And on top of it, the banks that get the support must be subject ot strict scrutiny and regulation in order to “earn” this support.

  • Johnny Evers

    I think we all understand that we need a banking system; however, that doesn’t mean we need to keep (insert bank name here) in business.
    If Bank of America fails, another bank can do the same job. If Lehman makes bad loans, another entity can come along and make better loans. Yes, Bank of America can be propped up a crisis, but it should be unwound after the crisis, and other competitors allowed to emerge.

    Really not sure what your long-term angle is on this site. Do you support this system wholeheartedly, or are you trying to show how rotten it is to advance the argument that banking should be entirely public?

  • http://orcamgroup.com Cullen Roche

    I think that’s an assertion that some people might challenge. Do we really “need” a banking system?

  • Johnny Evers

    Let’s hear it — do we need a banking system?!

  • http://orcamgroup.com Cullen Roche

    You tell me? :-)

  • InvestorX

    Well there are several questions:

    First we need a payment system, but it does not need to be merged with the credit system.

    Then we need a credit system that can be FRL or not. I am not 100% sure yet we can do as well without some form of FRL, but if FRL is allowed it needs to be regulated, especially in case it is subsidized.

    Then you have the shadow banking / IB system that needs to be definetely split from the payment and credit systems.

  • William Bedloe

    Private business are in many ways held accountable by their customers and by the government that regulates their businesses. In that sense, there is less fear of private business. However, as businesses grow in size and influence, so too does fear and mistrust. On the whole, Americans are naturally inclined to mistrust powerful, seemingly unnaccountable monopolies of any kind. With government, the last line of defense to protect the citizenry and its freedoms is the election process. Many now feel that even this part of the game is rigged – hence, the fear that government will get too big to rein in. While I agree that bashing government has become in many ways lazy thinking, it is healthy for a free society to push back against its government. If it did not, government would continue to grow and expand in power with no accountability.

  • genX

    Let’s start with your assertions.

    1) Without defining what you mean by ‘primarily’ this is just handwaving.

    2) The Government creates bonds, which the central bank purchases. Traditionally, the mechanism to prevent the government from printing an infinite number of bonds is (a) the willingness of investors to buy them and (b) the interest rate (yield) at which they are sold. Once you subvert that mechanism (like the Fed has), then there is no difference between the current system and one where the government directly issues currency.

    3) Banks are utilities, not industry. The goal of utilities is the cost efficient and effective distribution of the utility. In the case of banks, the utility is money. Maximising profit of a utility (which, by definition, is not a value adding industry) is only achievable through monopoly, which the current banking system most definitely is. Single currency, single issuer, one bank.

    4) Banking is unstable in a completely different way to any other capitalist entity. Compound interest in a world of linear growth is inherently unstable. I would show you the math, but this medium doesn’t facilitate that. The equations of banking have no equilibrium conditions.

    5) All monopolies are inherently dependently fragile. If you allow multiple methods or means of settling contracts of trade, other than a single fiat currency, then you remove the dependence fragility of the banking system. Monopoly control is the cause of the fragility, adding fuel by way of subsidy only compounds the problem. Debt as a means of capital distribution is inherently unstable and cannot be put into a steady state, regardless of intervention.

    6) Irrelevant. Try this “Every adult in America receives $100,000 per year from the government who has the incredibly powerful tool of taxation.” Taxes are not magic free money to be used to ensure investment bankers make their bonus, they are the investments of the body politic into the COMMONwealth.

    7) The previous banking system worked exactly the same as the current one, but the solution this time is much worse in the long run. Better to have a little depression than loss of faith in the entire system.

    Now the rest.
    ” For instance, it’s now clear that the bank bailouts in 2008 actually stabilized the economy to a large degree.”
    Unsubstantiated assertion. The bailouts shifted the risk from private banks to the corporation of the United States. Who bails out the United States government? That’s right, nobody. Ergo, the bailouts were highly inflationary.

    “Had we not done that, we likely would have seen an economic downturn that much more closely related to the Great Depression.”
    You still will, in time. The Schiller P/E index is now at 23.3, which means that corporate earnings have not been growing relative to their share price, and that 2.5 trillion of Fed liquidity has flowed into equity markets, but not yet into the broader economy, but when it does, will effectively double the m0 money supply.

    “In other words, if you support private banking and the system we have then you support bank bailouts at times. ”
    Your assertion is a non-sequitur. If you support private banking as it currently is implemented in the Western democracies, you need to accept that it is inherently unstable. You also need to accept that those who know it is inherently unstable have been making vast fortunes of this fact for 6 centuries, and will continue to do so as long as the system remains the same. The alternative to the modern banking system is to have a 100% equity system for private lending. Under that system, governments could still issue bonds, but private entities could only obtain capital through equity.

    5) All monopolies are inherently unstable. If you allow multiple methods or means of settling contracts of trade, other than a single fiat currency, then you remove the instability of the banking system. Monopoly control is the cause of the instability, adding fuel by way of subsidy only compounds the problem. The problem is that, debt as a means of capital distribution is inherently unstable and cannot be put into a steady state, regardless of intervention.

    6) Irrelevant. Try this “Every adult in America receives $100,000 per year from the government who has the incredibly powerful tool of taxation.” Taxes are not magic free money to be used to ensure investment bankers make their bonus this year, they are the investments of the body politic into the COMMONwealth.

    7) The previous banking system worked exactly the same as the current one, but the solution this time is much worse in the long run. Better to have a little depression than loss of faith in the entire system.

    Now the rest.
    ” For instance, it’s now clear that the bank bailouts in 2008 actually stabilized the economy to a large degree.”
    Unsubstantiated assertion. The bailouts shifted the risk from private banks to the corporation of the United States. Who bails out the United States government? That’s right, nobody. Ergo, the bailouts were highly inflationary.

    “Had we not done that, we likely would have seen an economic downturn that much more closely related to the Great Depression.”
    You still will, in time. The Schiller P/E index is now at 23.3, which means that corporate earnings have not been growing relative to their share price, and that 2.5 trillion of Fed liquidity has flowed into equity markets, but not yet into the broader economy, but when it does, will effectively double the m0 money supply.

    Your assertion is a non-sequitur. If you support private banking as it currently is implemented in the Western democracies, you need to accept that it is inherently unstable. You also need to accept that those who know it is inherently unstable have been making vast fortunes of this fact for 6 centuries, and will continue to do so as long as the system remains the same. The alternative to the modern banking system is to have a 100% equity system for private lending. Under that system, governments could still issue bonds, but private entities could only obtain capital through equity.

  • InvestorX

    Wow some very smart comments and I agree with your spirit.

    Only I think points 5-6 are not that clearly formulated and your comment on M0 is irrelevant as banks do not lend reserves.

    I maintain that this post of Cullen is apologetic and full of straw man arguments:

    CR: “For instance, it’s now clear that the bank bailouts in 2008 actually stabilized the economy to a large degree.”

    It is clear that they achieved that, as it was a bnaking panic crisis, not something else. But it is clear that using the Swedish model it would have achieved the same without the income redistribution, moral hazard and further concentration of TBTF.

    CR: “And yes, I know that some will claim that would have been a “cleansing” of some sort, but that doesn’t mean the downturn wouldn’t have been much longer and deeper (or unnecessary).”

    Nothing has been solved structurally, the problem has been postponed for a bigger calamity on a later date. Besides please stop with these claims that the 1800s were so much worse because of the gold standard and the depressions. The compound growth of real GDP (look at the data) was much higher (although more volatile) than over the last 30-40 years where your so beloved fiat currency system “blossomed”.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    I agree w/ InvestorX about your M0 comment. Especially when you consider that

    “M0: The total of all physical currency including coinage. M0 = Federal Reserve Notes + US Notes + Coins. It is not relevant whether the currency is held inside or outside of the private banking system as reserves.”

    It’s just the “physical currency.” Why would the physical currency in circulation double as a result of excess reserves? The amount of currency people chose to carry is not a function of excess reserves.

    Also, Cullen has never claimed that our banking system is stable. In fact he’s claimed it’s unstable on many occasions. PKE in general claims that capitalism isn’t stable… in fact the instability is part of what’s good about it (according to PKE). Minsky’s “Financial Instability Hypothesis” claimed that stability is inherently destabilizing.

    Debt based money systems preceded coin based systems by 1000s of years, and have been going in and out of fashion ever since. So I’m not sure there’s some terrible flaw in debt based systems. The most primitive and/or ancient systems were/are “gift based” economies which are proto-debt systems (in that the “debt” isn’t well quantified). There’s evidence those went back to the dawn of mankind if not prior (hominids in general seem to use a kind of gift based system). David Graeber is a good source on this.

    I’m not sure what you mean by “100% equity system for private lending.” How does that relate the usual concept of equity = assets – liabilities? Are you saying we need to have a 100% reserve requirement and restore the gold-standard? As for capital, it’s true that it isn’t exactly the same as equity (depending on what kind of capital you’re defining), but it’s the same concept: capital = set of assets – set of liabilities. Working capital and regulatory capital definitions all follow that pattern (e.g. the CAR). Or (sometimes) equivalently: capital = equity + certain liabilities. So I’m not sure what you mean by “obtain capital through equity.” I absolutely agree there’s a relationship between the two as I’ve laid out. What are you proposing that’s different?

    As for compound interest with linear growth not being stable… again no special stability claims are made by MR or PKE in general regarding the economy, but it’s fairly simple to construct a simple example that IS stable, even though compound interest is being paid. Consider a case in which a single commercial bank distributes all profits from interest as shareholder dividends, and those shareholders spend the money into the economy… this has the effect of re-balancing the overall debt to deposit ratio. For example, I might take out a credit card loan for farm supplies which I never pay off… but if the CC company employees and shareholders keep using all my interest payments for buying my vegetables then this allows me to keep paying my interest: you could could say that was a stable system… or at least a stationary system. Again, I know that’s a contrived example, but there’s nothing about compound interest in and of itself which necessitates instability.