Misunderstanding Banking is Helping Bankrupt an Entire Society

Much has been written since the JP Morgan trading fiasco and the big Congressional hearing last week – some of it enlightening, but most of it confusing some of the basic elements about banking and money in general.  I was reading this piece yesterday on Bloomberg about the responsibilities and the “job” of banks.  It got me thinking about how badly people confuse the role of banks in our system.  So I thought I’d chime in.

Banks are, at their core, profit seeking establishments that serve as the lifeblood of a complex payments system in the monetary system.  Banks make a profit by having liabilities that are less expensive than their assets (well, it’s more complex than that, but let’s keep things simple here).   They compete for deposits and business by offering various products and services.  In the USA banks are almost exclusively owned by private shareholders (as in, not the government or public sector).   Like most other private profit seeking entities the goal of a bank is not just to service the smooth facilitation of this payments system, but to to make money for its owners.  Most of the time, these two functions do not conflict, but at times the risks banks take can indeed jeopardize the functioning of the system.  Despite all the bad press that banks receive the progress surrounding their various services have actually had a positive impact on the world (for the most part).  Bank accounts, credit cards, debit cards, investment services, business hedging services , etc are all elements that make the institution of money more useful and more convenient.  Seeing as money is a tool and a social construct it makes sense that banks have evolved products and services to help facilitate the ease of its usage (all in the name of competition and profit generation, of course).

But we have to ask ourselves the question again.  What is Wall Street’s job?  Wall Street’s job is simple.  It is to increase earnings for their shareholders.  It is not to provide jobs for the private sector.  It is not to make sure the US economy is running smoothly.  It is not to make sure you feel good about your day to day life.  It is to generate a profit for its owners.  This is the essence of private banking.  To generate a profit.  But banks play a unique role in our capitalist system.  I’ve explained before that banks are not the engine of capitalism.  They are simply the oil in the machine.  As the oil in our machine, banks must be functioning smoothly in order for the machine as a whole to be functioning smoothly.  So when big banks do bad things that threaten their well-being parts of the system begin to malfunction.  And sometimes when these mistakes are big enough the contagion leads to the entire machine malfunctioning and requiring a major repair (hello 2008!).

But make no mistake, your local bank is not your best friend or a public purpose serving charity.  For instance, when a bank extends a mortgage (a word literally meaning “death security pledge” from the latin root “mortuus” for death and germanic “security pledge”) they are not doing you some charitable service to help you buy your home.  They are rating your credit risk and evaluating you as a potential profit engine for their shareholders.  That might not be the most pleasant way to think about it, but it is what it is.  A bank is not a charity.  It does not really care if your mortgage results in jobs or happiness for you.  Of course, it would be great if this did because that might result in more future business, but the bank does not need these things from you in order to generate a profit.  It really just wants to manage its risks in a way that helps to generate a profit for their shareholders without excessive risk.  Obviously, the debtor finds the mortgage advantageous, but don’t confuse this service for charity work.  It’s just good old fashioned profit seeking and offering a service where one is needed (in this case, the debtor being able to obtain money they could not otherwise currently obtain).

The business of private banking is largely about risk management.  A good bank manages risk by understanding how the various business components threaten the stability of the overall bank and align with this goal of generating a profit.   And as we ripped down the regulations structuring the amount of risk these institutions can and cannot take (in addition to making the risk taking business more complex) we realized that banks just weren’t very good risk managers.  This is not surprising to anyone who has been around markets for a while.  Investors and people in general are irrational, inefficient and poorly suited to manage the risks associated with complex dynamical systems.  So, for some reason, we all seem shocked when these profit seeking entities take excessive risks and prove to be poor risk managers.  And since we would never blame ourselves (the home buyers for instance) we blame the banking institutions.  And we write silly things about how they’re not doing their “job” or how they’re all out to screw the whole world.  It’s just not that black and white.

From a social perspective, this is all an extraordinarily interesting discussion.  Money is a social construct and a simple tool that helps us achieve certain ends within our society.  But money is something that is to be earned within our society (or utilized by the government in a democratic manner that is in-line with our goals as a society).  So there’s an interesting reality at work within the banking system.  Banks, as loan originators, act as a way to obtain access to money for someone who has not yet earned money.  And in return, they are charged a fee for “borrowing” this money that is technically not yet theirs.  If there was no interest fee attached to loans the demand for this money would obviously be through the roof and it would render it worthless.  Likewise, if banks make credit standards too lax, fail to properly asses risks and make credit plentiful they can create an imbalance within the system (by lending to people who can’t service their debt) that threatens the viability of the monetary system through the risk of excessive debt, defaults and inevitable de-leveraging (as we’re seeing now).  In this world of “what have you done for me lately” and “get rich quick” (or more often, appear rich quick!) you have a messy concoction of borrowers who want their McMansion YESTERDAY and lenders who are willing to give you the money to obtain that McMansion TODAY so they can generate a bigger profit TOMORROW.

To me, none of this is a conflict though and does not mean the system, at its core is corrupted or failing.  Banks are private profit seeking entities who play an important role in our society, but are not public servants and should not be public servants (a government managed loan system would almost certainly be a disaster waiting to happen).  Obtaining money is a privilege, not a right.  And a private profit seeking banking system serves to regulate the ability to obtain money before one has necessarily earned it (though there are certainly instances, such as some forms of government spending, where money is rightly distributed by political choice).  But because banks deal in distributing the social construct that binds our society together we have a responsibility to oversee that money so as to bring the interests of these profit seekers in-line with the interests of society as a whole.  So to me, it is not the capitalist profit motive that is evil here.  Nor is it the greedy consumption driven actions of the borrowers that is evil.  These are crucial elements of a healthy functioning monetary system.

I think we need to recognize that money is a social construct that is to be protected by the society that creates it.  But we must also understand that, while private profit seeking banks are a superior alternative to a government managed loan system, these banks will inevitably be poor risk managers at points during the business cycle.  There is plenty of blame to go around for the current debacle that is the US economy.  Home owners were greedy in the run-up and the profit seeking banks were quick to turn that extra demand into higher earnings per share.  This production/consumption component is a healthy functioning part of the capitalist machine.   But when it involves the very oil that greases the engine we must understand that this is a component of the economy that requires great oversight and better regulation.  I fear we still do not have this despite the recent changes.  And the result is that this boom/bust cycle is likely to continue causing people to believe the very essence of capitalism is corrupted when in fact, it is the users and their misunderstandings who have abused the system.  In failing to properly oversee the institution of money we have allowed it to fail us.

In sum, it is the misunderstanding of the essence of money that is evil here, not the system itself.  We have misunderstood the essence of money as a tool and a social construct and how it relates to modern banking.  And in doing so, we have allowed both borrowers and lenders to abuse that social construct.  And with 8% unemployment and a floundering economy it is not just the banking system that appears bankrupt, but our society as a whole.  Better oversight of the institution of money might not be able to fix our current problems, but it can certainly ensure that future generations don’t have to suffer through these same events.

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.

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  1. Cullen,

    I definitely agree with most of your posts. I completely support private profit-seeking capitalist institutions. Unfortunately, I’ve just come to the conclusion that banks aren’t private and they aren’t capitalists. Banks are backed by the government because they use leverage and disrupt the money supply if they fail. Real capitalist enterprises don’t alter the money supply – they just build capital. Once you get that banks are given the government-granted privilege of money creation, it’s hard to view them as capitalists. Banks create credit money. You say banks provide money to people who haven’t earned it yet, but banks aren’t lending money from their vault of stored cash, they are creating new money thanks to their government-granted privilege. The beauty of the banking business model is that you can create new unearned credit money, and then demand that credit be repaid with real money derived from productive achievement. If the borrower can’t repay the debt, the bank claims the collateral as it’s own property, even though the bank just started with credit money it created out of thin air.

    I think capitalism is an amazing economic system. I love rewarding productive achievement. I just don’t like banks because they are really just con-men masquerading as capitalists. I don’t fault you for your devotion to capitalism. I fault you because you are too quick to turn your back on the interests of the people who build capital.

    • Thanks for the comment Luke. I don’t think I turn my back on the people who build capital. After all, a big part of MMR’s work on S=I+(S-I) is focused on this point. The MMR Law further hammers this point home. Production is the key to any economy and capital formation is essential here. I am not taking that for granted. And I agree with much of what you wrote. I just think banks need to be regulated better and perhaps the compromise you and I agree on is that banks should have their profit generating potential reduced via tighter regulations so that they can play a more stabilizing role in the capital formation process???

  2. Cullen,

    Great topic. Since the banks are in effect peddling a product that they themselves are allowed to create at will, e.g. debt dollars, fully exchangeable with U.S. fiat currency, a product totally owned and operated by the Federal Government, backed only by law, then it’s only logical that the banks must be “owned” by the Government as well. Uncle Sam needs to be the only shareholder.

    I appreciate your comment above: “I think you’re overly confident in the ability of govt. loan originators to price risk. Not that private banks are great at it, but public banks will have almost zero motive to price risk accurately. Unless they’re regulated like crazy (the govt. regulating itself – that will no doubt work out, right!?!).” Cullen, it’s the same issue with the private banks because they can pass off the risk to someone else. Today, the private banks have absolutely zero motive to price the risk at all! Just shut up about it and sell the loans off and keep the origination fees.

    As to your idea “I wish we could have both” [private and public banks]; actually we kind of do with Fanny and Freddy being owned and run by the US. The banks can make little or no profit these days because the interest rates are so low, therefore they cannot take any chances with borrowers that might not pay the principle back. Today the only way to get a loan from private banks is if the loan’s principle can be at least partially guaranteed or actually backed up by Fanny and/or Freddy, or the bank must sell the loan off to suckers. The same is true with student loans most of which are now owned and operated by Uncle Sam/Sally Mae. You see — the bank’s managers and shareholders are taking all the profit (if any), and Uncle Sam is taking all the risk (which is now enormous).

    The problem is that the private banks screwed up completely in 2005-2008. It’s their fault that the made a total mess. They took lessons from the Savings and Loans, eventually the loans were covered Uncle Sam and the quasi banks were combined into the too big to fail “zombie banks” that the world has today. Now the world’s folks and public countries can no longer pay the interest to the private bank’s shareholders. It doesn’t work anymore! If you add up the numbers, we’re all insolvent. Further, there is no way out for the world. Each country needs to nationalize its banks (just like China), and pay off at least the un-payable publicly owed debt+interest with newly printed currency and significantly reduce the privately held debt dollars overtime. The banking industry of the world will survive as “publicly owned” and the people of the world can get going on all the work there is to do in the world that currently needs to be done. Will time and money be wasted? YES But the wasted dollars will not go to the bankers in the form of forclosures etc., the situation we have now. At least it will be fiat currency created by the various governments that is wasted and not people’s lives.

    • If the banks were “owned” by the government the government would have equity or an income stream from their earned income. The only “owners” of most banks are private shareholders. This is most certainly not government ownership. That seems pretty cut and dry. What’s to debate?

      • You’re correct SS. There is nothing to debate. As Cullen has pointed out MMR explains how things are in the world today and it’s beyond MMR to suggest what should be changed. The idea of nationalizing all the banks in the world is well beyond any current reality. All I’m saying is that the world’s bankers knew they were pushing the boundaries of the economic system of the world for it’s own profit (as Cullen points above), and it appears to me that we could be headed for a catastrophe. You can use MMR to help predict the future if you understand how the system works (as Cullen points above), but those in control either don’t understand or they do understand and they are only in it for themselves. BUT they have screwed up big time and so now we are all in danger. With this reality one could easily suggest that there was some sort of conspiracy that backfired. I don’t go for that. This likely happened with individual banker VPs trying to make a buck for their bank and getting a promotion or two. Even the bank shareholders had nothing to do with it. Looking at the current vs 2007 value of their shares, they paid the price if they didn’t dump or short their own shares. Question-what would MMR predict would happen if all the banks in the world were suddenly nationalized and the bank shareholders were only individual nations rather than individuals? I think this is worth considering since the reality is “Misunderstanding Banking is Helping Bankrupt an Entire Society”

  3. We all will just have to accept some kind of a compromize. More regulated banks will be less efficient but less error prone and vice versa. And there will always be some jerk (MF Global) that finds a loophole, no matter what. All we can do is pick a policy from the center of the bell curve and hope for the best. Perfection ain’t in the cards.

  4. Cullen,

    Thanks for this post. But isn’t it a bit of a contradiction to say you’re not promoting a policy agenda and then say things like banks shouldn’t be publicly owned?

    • I’ve been pretty clear about this. The conversation you’re referencing above has to do with MMT vs MMR. We intentionally did not embed policy in MMR. Yes, we all have differing policy perspectives and at times interject with policy views, but don’t confuse this for the core understandings of MMR. Just a few comments above Mike is disagreeing on the view that banks shouldn’t be publicly owned. But we all agree on the basic underlying operational realities like the fact that banks are privately owned for benefit of shareholders and serve self interests and not public purpose. They are not publicly owned and do not align their interests with that of the society as a whole (if you want to argue that SOME of the things banks do are in the name of public purpose then fine, but I am generalizing and I think most people would agree that most bank activities are done in the interest of shareholders and not public purpose). I don’t think those are controversial statements. But when I talk about policy I am not making a statement about MMR’s views. I should have been clear about this above. I am stating a personal preference. I personally don’t think banks should be publicly owned, but that’s a personal preference and has nothing to do with the current reality of the way banks operate in today’s environment. Mike disagrees. We’re both MMR co-founders so there you have it. Hope that helps clarify.

      • It’s refreshing to see you guys disagree on policy actually. Eliminates the “cult” feel.

      • MMT’s deception on this is so obnoxious. They want to convince us all that there’s a money monopolist so they have to say the banks serve public purpose. Then they publish articles left and right complaining about the role of banks in serving public purpose. They hypocrisy in this is unbearable. I don’t know why you continue to give them the time of day or even mention the letters MMT to your audience. They’re political ideologues with an axe to grind and they hate that you’ve abandoned them to wallow in their socialist misery. Stop talking about MMT. Even associating yourself with them at this point is bad mojo, Cullen.

        • This was never about MMT and I have no idea why anyone made it about MMT. Let’s just all agree to move on. This political bantering is exactly what I want to eliminate from the site. It’s pointless and usually devolves into childish nonsense that is totally counterproductive.

  5. Cullen:
    I agree with virtually everything you wrote in this article.
    I think the primary reason is that you speak about values, and the value of money, and how money should be “properly” utilized.
    It’s like most things in our society which are inherently neutral: sex, religion, politics.
    It is how these neutral items and entities are used or abused by people that make all the difference.
    The bankruptcy you seem to be referring to is a bankruptcy of properly using the privilege of money – it should be an honor, which is honorably used, as a win-win for all parties.
    Without that perspective, any monetary or political system will eventually become bankrupt, for the people themselves, at least the movers and shakers, have grinded our progress to a halt.
    Don Levit

  6. Just to throw in a historical note, a century or so ago, the banking houses of JP Morgan, Jay Cooke, and the worst, Jay Gould, had their fingers in every pie (notably RR’s) and manipulated in all the ways ‘Witt’ lists above.

    A few years ago, the New Yorker ran a piece on the writer Louis Auchincloss, whose novels document the NYC banking class of a later era, as well as the school where many sent their sons (Groton, created in a marriage of New York money and Boston pedigree and bankrolled by JP. Graduates: FDR – a somewhat anomalous relationship; Acheson and Harriman: one, the architect of policies that may have forced Japan into war, and then ‘containment’ of the USSR, the other, the wealthiest man of his era, and one or both present at Yalta, Bretton Woods, the founding of Nato, etc; McGeorge Bundy, one of the authors of Vietnam War policy; Cy Vance Jr, representing the next generation).

    According to the article. early on Auchinclosss basically defended this class, believing that it could help get a business off the ground, as well as giving ‘a good man, down on his luck, a break’ (my attendance at Groton while it was still ca 200 all male students, a result of efforts to diversify; nevertheless, the paucity of Catholics and especially Jews, led me to want to ask “would the ‘good man’ get the same chance if he’d gone to City College and summered in the Catskills, rather than Harvard and Fire Island?”) However, by the end of his life, he was pretty thoroughly disillusioned with the role this class played.

    (The article also included notions on the connection of Groton to the Vietnam debacle. My own, somewhat different conclusion, was that it was more a matter of parochialism, and narrow loyalties to classmates/colleagues than more contemptible influences.)

    US recovery from the ‘Robber Baron’ era suggests it can be done, However, ‘corruption’ or even ‘cronyism’ are perhaps too harsh as terms for the more subtle aspects of what must be dealt with: the current Harvard/Princeton-Goldman Sachs-Treasury/Fed nexus is an example.

  7. A corporations prime directive is to make money for its shareholders. You wouldn’t want it any other way. Imagine some idiot saying he just wants people to be happy so never mind about profit? How long wiill he be in business and what happens to your investment? If someone,does not like what the banks are doing, they need to change the regulations and put some teeth in those regs. Otherwise expect Jamie and his buds to keep on doing what they do.

  8. Cullen,

    Excellent piece, thanks. I would like you to broaden your stable of potential improvements to the system when your write articles like this. You have been consistent in suggesting that more regulation would, if not prevent repeats of the recent meltdown, at least make repeats less likely. I agree it would help, but I also feel strongly that too many people think bad behavior, bad risk management, can be regulated away…..it won’t and can’t.

    I’ve written before that people have the misplaced perception that regulations are like walls as barriers to bad behavior….they aren’t. A better analogy is a maze. The regulated employ the brightest minds to conceive ways to achieve their desired goals while staying compliant with current “regulations”…..and the regulated private banks will always have more wealth to employ brighter minds to navigate the maze of regulations than the regulators. So you end up with additional regulations on top of the prior ones, creating only more confusion, which to the regulated is opportunity.

    The better alternative, in my view and experience, is simply letting failure fail. Bailouts must end, and claw-backs of pay and bonuses from failed performance must be allowed. You will find that risk management will miraculously improve overnight. More thorough evaluation of counter parties and other due diligence will improve overnight. The fundamentals of good decision making have disappeared in our era of bailouts and default insurance.

    Ironically, in my view, more regulation only insures that bailouts will continue. Complying with every new regulation, providing the convenient “We did everything you asked us to do”, will be a persuasive argument when failure happens again and the failed management comes to govt once again with their hand out…….and be assured, failure will continue to happen even with more and more regulation. Thanks, krb

  9. Corrupt and criminal behavior happen all the time. If the Glass Steagall bill was not abolished, the damage in 2008 crisis will be much smaller.

  10. The above debates about whether banks should be privately or publicly owned seem misguided and based upon a poor starting assumption. That false unstated assumption is that we must allow the privilege of credit money creation. In my opinion, productive capitalists and laborers would carry on living their lives, and would be significantly better off, if nobody could expand the money supply with fractional credit. I’m not against making loans – I’m just against loans that aren’t made from savings, but rather, are made by making new money. Once you get that credit money is time-delayed theft, debates about who should do the stealing seem like a waste of time.

  11. Credit Money when borrowed comes into being as a tax on the future. It transits from the future to the present day. When that happens there is a rate of increase in the money supply. This increased rate of credit entering the supply causes it to chase after asset inflation. It gets more complicated as credit is confounded with money. Real money lent out of the vault at a bank has both velocity and its base amount. When credit money enters the supply, it fakes out the market with false velocity, and base numbers. In other words real markets for goods are faked out. Also, the market for money is distorted.

    Looking at banks, originally they were trusted partners that shifted money from one account to another. Mary would transfer to Joe, and the bank would be the trusted transference agent. But, banks got into the credit game, actually creating a lower form of money called credit.

    This credit is based on what the market will allow. The market is not omniscent,b ut is a creature of the law and signaling by money information. Markets use money to allocate goods, information and services. Looking closely at it, credit and banks create circular illogic. A banker attaches your house to his double entry ledger, creating a loan. The credit money, from the loan, enters the supply, often causing asset inflation, driving up the apparent value on the ledger and allowing more loans/credit to enter the supply. The circular illogic of credit works on the downside too. When the market collapses, it signals to the asset side of the ledger, and the bankers stop making loans.

    Money cannot be a social good if Credit money is the dominant form in the supply.

  12. Since money systems can only be observed through the lens of history, then government money systems have shown themselves superior to private formation of credit. It follows that private credit masters will host governments, and force the law to benefit themselves, thus forming a controlling unelected oligarchy.

    In the absence of law, markets will be directed by money, and the private profit motive. This is often antithetical to the good of civilization. For example, privatizing the public commons so that the commons can be tolled (through usury) benefits only a select few – the credit masters usually. Imagine all the ports, bridges, railways and public spaces privatized, as the credit masters are trying to do in Greece.

    Recent history such as that of the Greenbacks refute the notion that government money is a disaster. Greenbacks had parity with Gold at the end of the Civil war. The state bank of North Dakota did not get in trouble recently like private banks did. In fact, ND is doing just peachy, with its economy leading other states, the oil find nothwithstanding. The historical examples of Australia and Canada’s state banks are impossible to ignore.

    It is true though that Statist powers will try and seize control of the money power. That is why private credit formation is dangerous. It is also dangerous when the state becomes fascist or communist and controls the population similarly. In my studied opinion, the rightful place for money is as a legally safeguarded public issuance, but with private banks e.g. 100% reserve. This makes money money, and adds a layer of protection, keeping humanities predators at bay.

    • I don’t understand how banks could make loans with a 100% reserve requirement.

      If I deposit $1100 in a bank, it can loan that amount minus the reserve percentage – say 10%, and thus $90 to Mary. Now, assuming she deposits the loan in the banking system, it is true that this system now can loan $81 to John and so on.

      But if the reserve requirement is 100%, the bank would have to keep the entire $100 on deposit, and could only earn profit by charging me fees for holding my deposit, and processing transactions on it.

      I’m not sure how any credit would be available in this system. Would this requirement apply only to ‘demand deposits’ and not ‘time deposits’ like CD’s? Would the banks make loans from equity capital; or be able to borrow (based on some % of assets or deposits) from a CB at one rate and make loans at a higher rate – and how would this differ from fractional reserve?

      • Colin,

        You’re right. If we had 100% reserve requirements, then banking as we know it simply would not exist. Lending would exist, but lenders would have to surrender their purchasing power until the loan is repaid, the way grandma does now when she buys bonds. In other words, credit money would cease to exist and lending would not alter the money supply. Just as you suggested, credit would be much harder to come by, but the positive consequence you ignore is that assets such as land would be significantly more affordable due to the lower demand.

        More credit access to buy land causes land prices to rise – a negative consequence for all. Less credit access for land causes land prices to fall, making land more affordable for working people.

        • I am not ‘ignoring’ positive aspects – I’m pretty open to any workable alternative to the current dysfunctional system, which, I concur with Stieglitz, has led to unsustainable wealth and income concentration at the expense of working people and real democracy. I just want to know how the system ‘REN’ envisions would work.

          It sounds like the answer might be that credit would be based on ‘time deposits’ like CD’s – one of the possibilities I raised in my question.

          • Sorry Colin – didn’t mean to put words in your mouth. I think you have it right that time deposits are consistent with 100% reserve and demand deposits are most certainly not. The critical issue is that purchasing power must be surrendered by the lender during the duration of the loan such that the loan does not create new money. In other words, savings are the source of credit in 100% reserve, whereas the government-granted privilege of credit money creation is the source of credit in fractional reserve.

  13. State banking, while it has a better history than private banking, still does not fix the money problem. Why? Here’s an excerpt from the AMI:

    The problem is almost all of our money is created with a debt attached; it is ‘borrowed into existence’ from banks, who create it when we have to borrow it.

    As our economy grows, we need new money, but almost all of the new money is presently created with interest-bearing debt, so almost every new dollar has more than a dollar owing on it – so it has to ‘earn’ more than a dollar and pay it all back to banks (who never had it in the first place). Who owns and runs any particular bank makes little or no difference because the debt-based money-creating banking system will still own and run us, on a treadmill.

    Money doesn’t have to be created like this; coins aren’t, they’re just created as money, with no debt attached; when they’re issued, it’s revenue for the U.S. government, saving taxpayers $$$. All money can be created this way. And; if we don’t start with any debt, then we don’t start with any interest either.

  14. 1. Banks have been lobbying Congress for decades to get legislation passed that benfited consumers to take on more debt. Like taxdeductions.
    2. One Alan Greenspan reduced minimum bank reserve requirements in the early 1990s.

    There’s a reason why e.g. germans are more prosperous. German tax legislation is actually much less favourable for folks who take on debt.

  15. The Germans also have a mittlestand (sp?)banking system, which is state type banking. Small business in Germany has the same access to Capital at the same rates as do big business.

    With regards to 100% reserve, there is a weakness not discussed. It is the drain. In a credit system when you pay off your loan, it drains the money supply toward the bank, decrementing the ledger. However, in a 100% reserve system, the drain drains back toward the original creditor (us savers), and the money does not disappear.

    This means that a 100% reserve system will not be able to tune the economy easily during an inflationary period. Also, during crises people will freak and not make loans. IMO a 100% reserve system should have some component of State Credit. State credit can drain back to the state, offsetting taxes, and as well be a drain on the supply. To tune the money supply with interest rates, there has to be a drain.

    It would work like this: A bank is 100 percent reserve, and loans our our savings. At the same time, the Treasury has an account at all the private banks as well. Some state money is there on hand, so the private banker can loan it out as well. In this way, the central Treasury creates all money, but inteferes only minimally in the economy. Most money in existence is then money which had its origin in the past, and a portion of the economy isState derived Credit (future tense). Both forms of money in this system have high power so we can trade our output. State credit is much higher in power than the private credit we have now.

  16. With regards to Luke’s comment about land prices. The FIRE sector likes to attach land as an asset to the bank ledger. In this way, credit money has a counter in land. That means that land prices automatically go higher as credit money chases it. The FIRE sector will ALWAYS try to alter taxes such that land and financial assets are untaxed, while labor is taxed.

    Money systems have two main components, the fiscal side (taxes) and the monetary side (banking). Both are a function of the law and system design. However, in our credit banking system we live under today, the fiscal side is responsible and in league with the monetary side to drive land prices high.

    A good example: The total land costs of New York State exceed the value of all American business. Consider, if real money chased after real gains in a real economy, there will be a much greater output of wealth generation than what we have today. The distortions that private credit brings to a money supply and an economy make it hard for capitalism to work.

    • REN,
      I think we pretty much see eye-to-eye here, I just have a few minor quibbles. I think the term FIRE can be counter-productive because it avoids specifically defining where the thefts are occurring. In my opinion, fractional-reserve (credit money) and private land ownership are the two specific thefts within FIRE. However, there are many components of FIRE that are productive services. Housing is the productice capital component of real estate. Life/auto/health insurance, ATM/checking services, and financial planning are all productice services in the financial sector – it is really only the financial companies that create credit money that hurt others. Lumping the good and the bad into “FIRE” will allow the defenders of the status quo to correctly point of that you are antagonizing productive achievements.

      Further, your left-wing bias appears to be creeping through, which can be harmful if your intent is to build consensus. I think you’re right noting how the wealthy will always try to prevent land taxation, but I think you are incorrectly implying all of the tax burden shifts to labor. In my opinion, you are forgetting the large tax burden that low land taxes place onto capitalists as well. I think we need to crush the idea that labor and capital somehow antagonize each other. It’s the rentier class (landowners and credit money creators) that mooch off of productive labor and capital.

  17. Luke, thanks for the comments. It’s always good to see how others perceive. But, for the record, I’m a conservative. The reason I’m pro labor on taxes and money, is that I believe financial freedom is required in order for a citizenry to be vigilant against Statist powers. If the population are wage slaves, and everybody is working long hours, there is not enough energy left over to be a watchdog. Consider, we have just put the industrial revolution into hyperdrive with the advent of technology and high speed telecommunications. If you could go back in time and describe today to somebody in 1944 , they would be amazed and think we have a leisure society…but we don’t. The theft of wealth in a credit economy is astronomical.

    With regards to the FIRE sector, their products are useful in the right context. But, we are not well served when the FIRE sector owns the credit money power. AIG is a good example, where they helped lobby for the Graham Leach Bliley act, in order to break Glass Steagall. Then they proceded to counter party credit at banks making AAA loans. Dial in a little shadow banking. Let’s party and borrow from the future, and who cares if the world economy crashes. In a 100% reserve world, the FIRE sector would be constrained to its rightful place and peform useful services for fees. Sober individuals would be attracted to FIRE instead of the psychopathic behavior we see in Wall Street.

    There is this idea in textbooks that credit is borrowed and it goes to the factory for improving productivity. That is a nice view, where credit improves productivity. But, the reality is that most credit chases after land, especially in these times. More than 70% of the loans on the books are related to land. I don’t believe that labor and capital antagonize each other. I want capital to benefit labor; it can do this when it is real money. Labor can best save their output with real money, and not pseudo money such as credit. With a real money system, the need for safety nets is diminished and two income families become less of a need. These are very conservative notions, it is just that most conservatives are out to lunch when it comes to the money system.

    Consider, that by 1974, in Canada…who had a State Bank at that time; the population became self financing and had very low debt levels. Companies used their own profits to fund other companies and startups.

    • “I’m a conservative”. I wondered, but these conventional labels may have become completely outdated.

      “…perform useful services for fees”. Does this mean you don’t think banks should be in the business of making loans (and charging interest) at all – eg to small businesses? It also seems as though you believe RE princes could be low enough, and working incomes high enough that residential mortgage lending would also be unnecessary.

      This would mark a significant (should I say ‘radical’) difference, with even Luke’s position.

      • Colin, aren’t you implying a false choice? Your question about small business loans seems to imply that our two choices are either 1) No loans for small business, or 2) Allow banks to create new money to lend to small business. The third (and rather reasonable) alternative is to allow small business loans from savings such that loans don’t expand the money supply. That is 100% reserve lending.

        Our money supply is composed of currency (created by government, with no associated debt) and credit money (mostly created by banks, which transfers resources from productive citizens to credit money creators as debts are extinguished). If the money supply expands through the issuance of credit money, then private sector debt levels will expand. As private sector debt levels rise, economic potential declines, as more resources must be dedicated to debt service, rather than expansion of the capital stock.

        I have no idea how far land prices would fall without fractional reserve banking, but I believe it would be significant. I would hope that people would have learned by now that increased credit access for land purchases makes land less affordable, not more affordable, but I’m afraid too few people have gotten that message.

        • Luke,

          Once again, I am not trying to imply anything – only to understand REN’s position (I think I understand yours, and it is quite compelling).

          I realized after reviewing REN’s various comments that he probably did not mean to imply banks would only ‘earn fees for services’ and not from charging interest. I suppose they could charge ‘loan origination fees’, but it is hard to see how they could be the risk assessing and taking agent without setting and earning the interest differential between deposits and loans (subject to appropriate regulation).

    • Variation on a joke:

      “A liberal, moderate, and conservative walked into a bar. The bartender said, ‘You know Mitt – those labels just don’t mean what they used to anymore.’”

  18. I think maybe a label would be “freedom lovin.” We probably need new labels. Both Republican and Democratic parties house Statists. In the case of Repubicans, it would be Rockefeller types who would make the population into wage slaves. This is done by creating unbalanced economies and using the credit mechanism. From the democratic side, they want political statism, which leads to communism and fascism, and then mass death. Statists of both persuasions are the real enemies, and the core driving force is the pride defect in man. We look in the mirror and it is us. But, I’m much more conservative than liberal. I would like to see single income families and power returned to sovereign individuals. A whole host of social ills would disappear. With money power returned to people and their individual states, our Federal structure would start working again.

    The founders had the right idea, in that powers should be balanced to keep man’s excesses from causing self destruction. They left it up to us to figure out the money power, but we seem to be failing at that. Too many special interest oxes will be gored.

    The most equitable form of taxation is land rent value taxes. Economists call it the free lunch; and for many reasons…mostly because land does not follow supply and demand curves. The reality is that money can fly out of your wallet to pay usury on loans, or it can go to pay taxes. Think of usury as just another tax, but going to pay the new oligarchs. Californian’s are a good example, they pay both high personal income taxes AND pay high debt levels on their homes. If you tax the rent value of land, then the scenario of growing debt for land never occurs. With 100% reserves, and rent value taxation, land prices would drop, but the tax stream would take up the difference. Income taxes would drop to zero and money would become stable. Much of the unproductive financial theft would return to productive labor.

  19. REN,
    If you favor 100% reserve lending and land value taxation, then we are pretty much on the same page. But I think saying you are anti-statist is false. Land value taxation is a form of socialism just like income, sales and payroll taxes are. Land taxes just socialize community-created value rather than socializing productive individual achievements as taxes on labor and capital do. Land value taxes are the best path I can fathom toward free markets for capital and labor. The refusal to tax land ensures labor and capital will pay the prices through higher taxes and higher land values.

  20. I look at it like I do gravity. It is a force and it can make me fall down and bump my head. The same goes with an economy. There are certain rules that history teaches us, and if we don’t learn them, we fall down. It usually leads to war.

    One rule is that there are four modes of production: Land, Capital, Labor, and the Public Commons. With regards to the public commons, we all use roads and infrastructure to make our society more productive. People here argue over the nature of capital, so I won’t go into it. Labor puts capital to work creating wealth. Land is required to convert energy from the sun, and to give up stored energy in the form of minerals.

    If you tax income, then that reduces spending on the productive side of the economy. If people are in debt, they cannot spend on the productive side of the economy. If you tax Labor, that reduces the ability to create and be productive.

    Capital can accrue unnaturally, as in rentier income, and as in financial transactions. Land can be monopolized, and thus stored energy can be brought into the now, creating capital advantage. Witness land cattle barons, oil cartels, etc. Land also does not follow supply and demand. More money does not equal more land, but instead asset inflation.

    So, of all the taxes, tax on land and finance is the most equitable. Taxes on income and labor cause negative outputs in my estimation.

    Since the magna carta, we in the West have given up a measure of our sovereign power. Sheriff’s for example, derive their power from the people to make arrests. This power actually resides as a natural right of the individual. Our Federal structure codifies that idea that we give up some of our power to the “social” structure. But, I wouldn’t call is socialism, but instead Federalism. Socialism implies that the power is owned by the state and is handed down from the top. That is the opposite of what I imply. Some power is handed to the State by us to do our bidding.

    The same goes for the money power. We the people own the money power and we give a measure of it over to the State to govern on our behalf, much the same as our police powers are voluntarily given over to Sheriffs. Private unelected credit masters do not deserve credit money power. Likewise, we should demand our elected officials tax appropriately according to economic law.

  21. Luke, sorry that was me above. I’ve enjoyed it. Thanks for the insights, I think this subject could take a lifetime to completely understand, especially how history and economics are so interwoven. I see the money power as the hinge of all history.

  22. Collinstoe, In a 100 percent reserve world (I advocate also for some percentage of State Credit), banks earn fees for financial transactions. These fees could be considered interest if you want. They represent a transfer of wealth to pay for their services. Bankers should be trusted partners who intermediate between creditors and debtors. Creditors are savers who have extra money to loan out to people who want to borrow.

    Bankers should not make money and engage in a market for money. The credit money scheme, connected to markets, guarantees inflation and depression by its very nature. In the upper middle ages of England, bankers would go to the big fairs and settle debts between creditors and debtors. The population used debt free Talley sticks to pay taxes, and the banker would earn fees for their services.

    For long term mortgages, a 100 percent system could be easily handled with a mutual fund type arrangement, where savers park their money long term under a legal framework.

    Money is a creature of the law, and has a force component. Also, any system design predicates its output.

    MMR is interesting in that they are attempting to describe our system. I wish they would look at the fundamental nature of money though. I see some movement with MMR averting their transfixed gaze from government and toward private credit.

  23. Amen. And that’s why banks would prefer that a debtor doesn’t repay the loan (e.g. mortgage) at all. Then the bank continues to receive the maximum amount of interest “”from here ’till the kingdom comes”" on the loan.

    And mr. Michael Hudson (www.michael-hudson.com) agrees.