The leading front page story in today’s Financial Times is entitled: “Carney tears up rule book on help for struggling banks”. Basically, he is going to offer more “help” to private banks with liquidity problems than Mervyn King did.
Sweet of him to offer “help” to those desperate, needy private banks, isn't it? I mean their “need” is far greater than that of the unemployed or pensioners.
But enough sarcasm. Lets get down to economics.
No one should be impressed by Carney’s “help” or “generosity” because of course someone, somewhere pays for this “generosity”, and it’s the UK taxpayer, or UK citizens in general, taxpayers or not.
Carney’s misapprehensions are of course not unique to him: that is, the misapprehensions as to exactly what banks are and what they do is widespread. And some very relevant mistakes and misapprehensions appear in a Bank of England paper published at almost the same time as Carney’s speech.
The paper points out (p.1,4th.paragraph) that banks borrow short and lend long, and then claims that it is “inefficient for banks to self-insure against liquidity risks . . by holding excessively large stocks of safe liquid assets..”.
Well that’s no different to saying it is “inefficient” to erect buildings made of non-flammable materials, so we should use flammable materials, with the taxpayer footing the bill when buildings burn down.
Put another way, never mind the word “inefficient”. The correct word is “cost”. That is, if the REAL COSTS to a bank of making £X worth of loans is £Y, then the bank and/or those taking out the loans and/or those funding the loans should bear the full cost. It’s not the job of anyone else in a so called “free market” or “capitalist system” to subsidise or stand behind banks, borrowers, depositors and so on.
So how do we prevent commercial banks sparking off systemic problems, without having them scrounge off the taxpayer, or publically owned institutions, like the Bank of England?
Well the solution is simple. It’s the solution advocated by Profs. Laurence Kotlikeoff, Richard Werner, plus Positive Money and many others: forbid or curtail “borrow short and lend long”. That is, if depositors want interest on their money, they must face the fact that that can only be done by investing or lending on their money long term. And that in turn means that while they will normally be able to get fairly quick access to their money, there is absolutly no way they can be GUARANTEED quick access.
There are different ways of enabeling depositors SOME SORT OF ACCESS to their money, while not guaranteeing them instant access to the exact sum they depositored. My favourite is the one advocated by Laurence Kotlikoff.
Under his system, depositors wanting interest on their money simply buy into a unit trust / mutual fund of their choice: i.e. they can choose to have their money used to fund risky mortgages, safe mortgages, loans to high tech firms, or whatever they like. But if large numbers of other unit trust investors want out, then the value of the trust units declines (as is the case with any unit trust). And that means subsequent withdrawers lose some of their money if they cash in their chips.
It also means that the much vaunted “liquidity risks” to which the BoE paper refers just don’t materialise: the bank is not under an obligation to repay any SPECIFIC sum to ANYONE.
Or as George Selgin put it, and in reference to banks, “For a balance sheet without debt liabilities, insolvency is ruled out…”.
Is central bank created money taxpayers’ money?
Some defenders of the current banking system will doubtless try to rebut the above sort of argument by claiming that money freshly created by a central bank ex nihilo has not come from taxpayers, thus having central banks stand behind private banks does not involve a cost to the taxpayer or citizens in general.
To answer the latter point, suppose that in the absence of central bank liquidity support, about one commercial bank per year goes bust. And let’s also assume that the economy is at capacity. That is, any more demand would mean excess inflation.
The latter “once a year” insolvency or bankruptcy has a deflationary or “demand reducing” effect. In particular, depositors lose some of their money, so they spend less.
So, there are so to speak two options there. One is to let about one bank a year go bust and make up for the deflationary effect by printing £Z a year and spending it into the economy (and/or cutting taxes by about £Z). The second option is to have MORE demand stem from commercial bank activity, thanks to the £Z being used to rescue banks with liquidity problems. But that of course means spending £Z a year LESS on “spending money into the economy and/or effecting tax cuts”.
Conclusion: money which is freshly created by a central bank and is used to support private banks which are in trouble, is money which could be put to some other use. Ergo it is effectively taxpayers or citizens in general who pay for bank bail outs.
Or in plain English, as anyone with some common sense knew all along, there is no such thing as a free lunch.
P.S. (31st Oct 2013). There was an article by Martin Wolf in the Financial Times on the 29th Oct that was similarly skeptical about Mark Carney’s ideas.