Saturday 14 July 2012

Banks behaving better shrinks the money supply!

The population at large are demanding that banks behave better. In turn, this is encouraging some politicians to demand that banks behave better. So presumably a raft of strict new rules and regulations will swiftly be put in to place to control the banks… won’t they? Well not as long as we keep hold of our crazy fractional reserve system.

You may have noticed that the new rules and regulations to control bank excesses appear to be both rather timid and slow to be applied. For example the recommendations put forward by the much trumpeted Independent Commission on Banking were rather weak to start with, have since been watered down, and even then are not due to come into force until 2019!

Most people are assuming that the reason for all this timidity is that the politicians are in the pockets of the banks. The political parties receive significant bribes, oops sorry, I mean campaign contributions from the banks and so are reluctant to do anything that may upset them. But there is a second, more significant reason that is scarcely mentioned in the media or known about by the public. Namely that in a fractional reserve system, banks behaving better shrinks the money supply.

Much of the bad behaviour of the banks involves the lending of money for non-productive purposes, like the purchasing of houses or the purchasing “on margin” of shares on the secondary market or derivatives. But as we know, lending creates money and repaying loans destroys money. So any curtailing of lending, even bad landing, simultaneously shrinks the money supply. What’s more, a smaller amount of money creation for purchasing assets reduces the value of those assets. If banks are holding these in order to comply with capital adequacy regulations then this will result either in banks going bust, or banks having to receive even more bailouts than they have already.

Now you can see that the idea of making banks behave better has a double-whammy of resistance.

As I have said many times before, if we instead had a system of full reserve banking, then none of this nonsense would be going on. The money supply could be held constant… Maybe I should make this my catchphrase?

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