Na­tion­al­is­ing money is an odd way to fix mar­kets

Switzer­land is vot­ing on whether to rip up the rules of bank­ing, but is it ready for the con­se­quences?

The Daily Telegraph - - Letters to the editor - JEREMY WARNER FOL­LOW Jeremy Warner on Twit­ter @jere­my­warneruk; READ MORE at tele­­ion

One of Switzer­land’s defin­ing char­ac­ter­is­tics is its love of ref­er­en­dums – di­rect democ­racy in ac­tion. Many of th­ese votes are on rel­a­tively ob­scure – or seem­ingly triv­ial – mat­ters, a de­scrip­tion which might seem to ap­ply in spades to one of the two na­tional plebiscites sched­uled for this week­end. Yet the ap­par­ently ar­cane na­ture of the sub­ject mat­ter is in this case de­cep­tive, for it speaks to a mass of seething, anti­estab­lish­ment dis­con­tents and yearn­ings which are very much of our time and not at all uniquely Swiss; it’s called Voll­geld, or the sov­er­eign money initiative.

There is no sim­ple way of ex­plain­ing the is­sue, so it is per­haps best to start by set­ting it in the con­text of the Global Financial Cri­sis, the start of which is com­ing up for its tenth an­niver­sary. Only now are the wider con­se­quences of this calamity be­com­ing clear. It was not just an eco­nomic dis­as­ter which de­stroyed trust in bankers and fi­nance. It also un­der­mined faith in lib­eral po­lit­i­cal and eco­nomic elites more gen­er­ally, catalysing a process of alien­ation that has swept all ad­vanced economies.

At the heart of this cri­sis was money, and more par­tic­u­larly the free­dom that bankers en­joy in cre­at­ing it. “It is well enough,” Henry Ford, ar­guably the most trans­for­ma­tional busi­ness­man of the 20th cen­tury, is re­puted to have said, “that peo­ple of the na­tion do not un­der­stand our bank­ing and mon­e­tary sys­tem, for if they did, I be­lieve there would be a rev­o­lu­tion be­fore to­mor­row morn­ing.”

In­deed so, be­cause although you might think that gov­ern­ments and cen­tral banks are the ul­ti­mate ar­biters of the money sys­tem, that’s not quite how it works. Pri­vate bankers are in fact the prime movers in the cre­ation and de­struc­tion of money.

It’s amaz­ing how many of us, up to and in­clud­ing some of the most se­nior bankers in the land, don’t prop­erly un­der­stand this dy­namic.

Here’s how it works. Ev­ery time a banker makes a loan, he must fund it with de­posits and cap­i­tal. Yet the loan it­self is es­sen­tially new money which will end up in some shape or form get­ting de­posited back in the bank­ing sys­tem, thereby al­low­ing the cre­ation of fur­ther loans. Some might call it a Ponzi scheme. The only lim­its on this process of credit ex­pan­sion are the banker’s in­stinc­tive fear of mak­ing a bad loan, and the frac­tion of de­posits he is obliged to hold as re­serves against the pos­si­bil­ity that de­pos­i­tors want their money back – hence the term “frac­tional re­serve bank­ing”.

Dur­ing the bonus-fu­elled credit bub­ble of the 2000s, liq­uid­ity buf­fers were al­lowed to fall to dan­ger­ously low lev­els. When con­fi­dence col­lapsed, many banks had in­suf­fi­cient re­serves to meet de­mand from de­pos­i­tors for their money back. Bankers went vi­o­lently into re­verse, con­tract­ing credit and there­fore de­stroy­ing money with the same dis­re­gard as they had cre­ated it. The econ­omy cratered ac­cord­ingly.

Thus far, pol­i­cy­mak­ers have re­sponded to th­ese events by bail­ing out the old sys­tem, patch­ing it up, and sup­pos­edly mak­ing it safer. Al­ready the power of the bank­ing lobby is be­gin­ning to erode the re­form agenda.

What pro­mot­ers of Voll­geld pro­pose is an en­tirely new sys­tem, which by forc­ing bankers to back all de­posits with cen­tral bank re­serves, couldn’t be sub­ject to runs, pan­ics and sol­vency con­cerns.

It would there­fore go some way to an­swer­ing pop­u­lar de­mand for radical change, at a stroke strip­ping the elites of their priv­i­leges and tax­payer­funded back­stops, and tear­ing down what Michael Gove, no less, has this week called a rigged sys­tem that con­cen­trates eco­nomic power in the hands of a few crony cap­i­tal­ists.

The Swiss, on the other hand, are much too sen­si­ble and cau­tious to vote for such an up­heaval. There are two ob­vi­ous draw­backs. The first is one of prin­ci­ple. Do we re­ally want a sys­tem in which gov­ern­ments, rather than mar­kets, are en­tirely in con­trol of money cre­ation? That politi­cians would do it bet­ter than bankers strikes me as deeply un­likely. The sec­ond is one of prac­tice. The dis­rup­tion in get­ting from here to there would be mon­u­men­tal, and as Franklin D Roo­sevelt con­cluded dur­ing the last great bank­ing cri­sis in the 1930s when con­sid­er­ing a sim­i­lar pro­posal, scarcely worth the risk.

This might be hard to credit given recent events, but warts and all, frac­tional re­serve bank­ing has on any long-term per­spec­tive ac­tu­ally served us well; its rule has co­in­cided with the most re­mark­able pe­riod of growth in liv­ing stan­dards and out­put in his­tory.

Nor, given ad­vances in tech­nol­ogy, does this any longer need to be a one or the other choice. The craze for al­ter­na­tive cur­ren­cies such as Bit­coin has gal­vanised cen­tral banks into think­ing about their own dig­i­tal cur­ren­cies, which like Voll­geld, would for the first time give or­di­nary de­pos­i­tors ac­cess to risk free cen­tral bank re­serves. Bring it on.

Rarely do rev­o­lu­tions work out well. Much bet­ter the evo­lu­tion­ary ap­proach, al­low­ing the best of the old to be mixed with the shock of the new.

We can tear down the gates of mam­mon if we like, but what, pray tell, lies be­yond?

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