Tuesday, February 25, 2014

Private banks just exacerbate booms and busts.

In relation to banks, Martin Wolfsaid “I accept that leverage of 33 to one, as now officially proposed is frighteningly high. But I cannot see why the right answer should be no leverage at all. An intermediary that can never fail is surely also far too safe.”
I gave some answers to that question here.And here is another answer….
The higher are capital ratios, the easier it is for private banks to lend money into existence. E.g. if the ratio is 5%, banks only need one pound of extra capital for every nineteen pounds of extra lending. Now what do private banks do with that freedom? That is, are the main gyrations in their money creation activities explained by sudden upsurges in the number of worthwhile and viable industrial investments?
Well as should be obvious to everyone apart from new-born babies and the inmates of mental homes, “worthwhile industrial investments” has nothing to do with the gyrations in bank lending. The gyrations are explained almost exclusively by outbursts of irrational exuberance: e.g. house price bubbles. For example in the three years or so prior to the recent crises, bank lending (red in the chart below) in the UK was expanding far faster than the expansion of base money (blue).

And of course the state (in the form of the central bank and/or treasury) have to counteract those gyrations.
So why not just ban private money creation altogether, first, because the state already creates a form of money, i.e. base money, and second, if private banks are allowed to create money, that simply leads to instabilities which the state has to counteract?

No comments:

Post a Comment