Billions For The Bankers

How sustainable is the debt inflation created by the banking system?

Francis

If you believe Robert Peston then all the "growth" during the "boom" was simply increased leverage. Who's fault it that I wonder?

Banks are and should be deleveraging right now and we (the tax payer) should not be propping up this flawed system.

She's not talking about CEOs, she's talking about the senior people allegedly responsible for managing risk, who suffered spectacular collective failure to grow balls when that's what they were being paid for.

Mike

"allanbonnetracy" wrote

When has it ever done that?

Prices going up between 10-fold and 30-fold in just 13 years? It didn't even do anything like that in the 13 years upto 2007...

"allanbonnetracy" wrote

Hmmm. Sustainability, or over 13 years only?

Banks don?t dictate to markets, they can?t, they can only respond to markets.

The housing market was hyper-inflating and the banks simply responded by offering ever more competitive mortgage products.

In this they had no choice because firstly, for those banks that got into trouble, mortgages were their business and secondly they could not collude with the other banks to moderate their products, as this is illegal.

Some banks, notably Lloyds, did take a step back from the housing market; they could do so because they had other business sectors to rely upon but other banks, such as B&B, did not have this luxury they were 100% mortgage banks.

Inflation is the responsibility of government one of the largest (most expensive) components of inflation is the price of houses.

Gordon Brown removed house prices from the inflation calculation, used by the BoE to set interest rates.

Gordon Brown believed house (asset) price inflation did not matter, as overall inflation could remain low thanks to the deflationary effect of cheap Asian imports.

Gordon Brown needed the hyper-inflating housing market to generate spending taxes for his spending plans.

Gordon Brown ignored all the warnings he was receiving about the level of consumer debt.

Gordon Brown believed the global financial meltdown, started in America and no one saw it coming.

No, I was thinking of fractional reserve banking and its inflationary effect.

Francis

Agreed, but crucially that money supply is influenced by central banks raising and lowering interest rates.

The BOE raises or lowers interest rates in order to control that inflation.

So, any inflationary effect should be met by an increase in interest rates slowing down the money supply due to fractional reserve banking.

Of course, house prices, a significant factor of inflation, were simply missing from the central banks interest rate calculation so interest rates were being held artificially low.

House prices then became an ever-growing component of wider UK inflation.

But this was not being reflected in the official figures, in effect the whole economy was hyper inflating (whilst the figures actually said inflation was low), the BoE was powerless to control it and the Government was in denial that it was even happening.

Bankers may work hard, but then so did Osmada Bin Laden.

Apparently serial killers enjoy what they do, and serial killing is not a 9am to 5pm job.

Bankers like serial killers create nothing, they just get huge bonuses taking small (or not so small risks) with other people's money. If they lose, they only lose their clients money, they still get bailed out, because they are considered "too important" to fail. Economic black mail / terrorism if you ask me.

Scum the lot of them.

P.S. at least Dick Turpin had the decency to wear a mask

What I have in mind is more fundamental than that. It is the system's requirement for economic growth that makes me wonder about its sustainability - the sort of thing talked about here:

Fractional reserve banking seems to have wealth-stealing (from us!) hardwired into it. Should we be worried about that, or is it a chimera?

Francis

Fractional reserve banking has been around for hundreds of years it is regulated and ultimately under the control of central banks.

Historically, the practice has not stood against the cause of sound money, in a low inflation economy, as ultimately governments and central banks can have no excuse for tolerating inflation provided they have the appropriate instruments of control.

My point about house price inflation was that the appropriate instruments of control were removed from the system.

Fractional reserve banking is practiced globally and, if you believed the financial crash really was global, then just maybe you could look towards the practice as the cause.

However, the global recession argument falls apart daily and certainly every European commentator (economists and politicians) point to the causes as being entirely Anglo Saxon.

It wasn?t really a case of too much lending but too much bad lending that caused the banking crisis.

More to the point, too much lending on inflating assets that tuned sour when those assets stopped inflating in price.

The banking system collapse was to be expected under such strain, far better that it had not been put to the test.

And is there any mechanism in place to stop this happening again, or to stop central banks from inflating the economy by enabling the creation of fiat money?

My original question of sustainability relates to statements like the following:

"Because fractional reserve banking requires exponential economic growth to avoid inflation (since the monetary supply grows exponentially under it,) inflation is very likely because as soon as the economy stops growing exponentially, we will see the currency inflate."

Clearly exponential economic growth is unsustainable, so how can inflation be prevented (and not just postponed) assuming the above statement is actually true?

Would reducing the allowed money multiplier - perhaps all the way to unity - help to limit that component of inflation inherent in the fractional reserve system?

I do take your point about house price inflation. However, what I have been asking about is a separate and potentially (if not currently) problemmatic issue.

Francis

It's obviously wrong. Fractional reserve banking prevents the money supply growing exponentially.

I'll do it from first principles: Let P be the fraction that can be reissued (so 1-P is the "fractional reserve")

If we start with a deposit X and assume that the money is recirculated and issued we get:

Y = X + PX + P^2X + P^3X + ... Where Y is the total money supply generated from X.

Multiplying by P we get PY = PX + P^2X + P^3X + P^4X + ...

Subtracting the second from the first we get

(1-P)Y = X

so Y= X/(1-P)

This is undefined when there is no fractional reserve (P=1) (so you could argue that the money supply grows exponentially) but is well defined for all other P.

You can argue that the chosen value of P (or 1-P) was wrong. P=1 means that there is no bank lending at all, no mortgages, no credit cards, no overdrafts, no bank loans. P=0 means that there is no limit on the amount of money banks can print. Anything else is regulating how much money is in circulation and should be designed to balance people who want to save against people who can use money to grow the economy e.g. by setting up a business.

Tim.

In the long run yes. It's a big universe though, so the long run could be counted in the quadrillions of years.

FoFP

I was talking about our activities on this planet, a rather more realistic set of parameters imho.

Francis

That simple, huh? I'm impressed!

Would 100% reserve banking mean an end to all bank lending?

Francis

Not to all bank lending. It would just mean they could not lend any money which savers had deposited with them in ordinary short term more-or-less-instant access accounts, and consequently it would spell the end to savers earning interest on their savings, they would instead have to pay the banks fees for keeping their money safe.

This would not preclude the setting up of investment-type accounts where people put their money into for the specific purpose of allowing banks to lend it. But here the customers would be aware that there is some risk associated with it, or at least terms which preclude getting your money back except after a specified period.

But having all this ordinary deposit money stagnating in banks, not circulating, will have an adverse effect on the wider economy, which would force central banks to create more money. This would lead to inflation as soon as people started to spend their savings.

It depends on precisely what you mean by a bank.

If you consider banks to be places where you put money for use some time in the future and the depositor can control when they get their money back then yes, 100% reserve banking will mean an end to all bank lending.

If you consider banks to be places where you can deposit money for the bank to invest on your behalf for a period you can specify (but there is NO opportunity for you to withdraw any money early) then some bank lending could continue.

Short term loans (3-5 years) probably could continue. There are plenty of people prepared to deposit money on those terms (these sorts of accounts tend to be called bonds rather than savings accounts)

But credit card debt, overdrafts and mortgages it is hard to see how they could continue. There aren't many people prepared to deposit money with no possibility of access for 25 years or more. (It's not completely true because, for example, I've currently got a significant sum of cash in my pension fund which, under current regulations, I will not be able to access for about 25 years. N.B. I'm not committed to keeping it in cash)

Credit cards and overdrafts could probably be made to work based on shorter term deposits but you'll get into the situation where a few non-payers means that the bank has to start calling in all the other loans. You'd end up with regulation that says how many years control over the deposit the bank needs in order to be able to lend it out on a "rolling debt" sort of basis. If (when) the meltdown eventually happened the same people who currently are screaming about fractional reserve banking would instead be screaming about "rolling debt banking".

IMO Fractional reserve banking makes a lot of sense. But it's important to set the level correctly. I also suspect that the ideal level is not constant over time. I've not done nearly enough studying of the current credit crunch to be able to say if the levels of fractional reserve were a minor component or a major component of what went wrong.

Tim.

Helpful reply, thanks Tim!

I found an interesting hybrid alternative proposed, here:

Francis