Although the current crisis is possibly the most serious and complex in human history, it follows a pattern that has existed since ancient times. The rulers of early civilizations, like that in Mesopotamia, had wiser solutions than today’s politicians. When the landless and other dispossessed people in these ancient societies ran up unsustainable levels of debt which threatened widespread economic ruin, they bit the bullet and tackled the problem head on. The authorities periodically made clean-slate proclamations: all debts were written off. This had the effect of resetting the economy to its original condition. Money lenders would suffer a nominal loss of wealth, but because things had become so out of kilter they understood they weren’t going to get their money back anyway. It was accepted that such debt jubilees were the only way out of crisis.
This is the point we have reached today, yet the solution offered by most economists and politicians is to borrow more money to refinance debts that are never going to be repaid. In short: create more debt to solve the debt crisis. It’s like encouraging a drug addict to take more narcotics to ‘cure’ their addiction. The only way out of the current crisis is to declare the slate clean in respect of banks that can’t give a full account of their exposure, and those nations which are unable to meet their debt obligations. Anything else will tear those nations apart. This would mean some privately-owned banks going to the wall, but it would prevent the same thing happening to entire nations.
It may sound like an extreme solution but it would focus the pain on those whose negligence and hubris caused the crisis. The alternatives: continuing to allow private banks to seek more profit by constantly refinancing un-repayable debts, or allowing central banks to create new money instead, would only exacerbate the problem and lead to deeper pain once we finally wake up and face reality.
The process of wiping the slate clean would have to be carefully coordinated across borders. If that seems an unlikely prospect, then we must use democracy to force politicians to take the only sensible way out of the crisis. Ordinary citizens in all ‘leading’ nations are being hit badly. By deepening and extending the kind of international coordination exhibited by the Occupy Movement worldwide, people could work together to force their governments to act in concert before it is too late.
The two quite distinct functions of retail and investment banking must be separated. This requirement was apparent to everyone during the Great Depression when the United States government passed the Glass-Steagall Act, prohibiting banks from engaging in retail and investment activities under the same corporate umbrella. Glass-Steagall was repealed in 1999 by Bill Clinton, under pressure from the banking lobby, several of whose leading members he had appointed to key advisory posts.
If banks were prevented from fulfilling this dual role, the deposits of ordinary savers would be protected in the event of a repeat of the kind of liquidity crisis that hit the system in 2008. Retail banks would have to stop creating money to lend to their investment arms for speculative purposes, and this would reduce the extent of non-productive investments which so destabilize the banking system.
In the UK, the recent report of the Independent Banking Commission at least acknowledged this problem but pathetically argued only for ‘ring-fencing’ the speculative activities of banks to better protect their retail customers. To add insult to injury, they gave banks seven years to enact the reforms. In the meantime, the government is obliged to guarantee people’s savings up to £85,000 while the banks’ profits return to pre-crisis levels.
The only way to ensure no repeat of the current crisis is to dismantle the banking system and rebuild it along lines that recognize the special status of money in the economy, and the importance of money supply stability. In addition to the separation of retail and investment banking, and curtailing the activities of shadow banking, the banking system should be split into many smaller banks so that mistakes made by one or a handful of banks do not infect the entire system. If banks do make poor lending and investment decisions, they must be allowed to fail.The culpability of the banking system for the current crisis should by now be quite obvious. But there is more. Since financial markets were deregulated three decades ago, and since technology changed the way players in those markets do business, an entirely new level of financial engineering has emerged in the ‘shadow’ banking system. Shadow banking activities generally occur off balance sheet – they are neither reported on in company accounts nor subject to any kind of regulation. The size of the sector is difficult to measure, but at its peak in 2007, Tim Geithner, now US Treasury Secretary, estimated that shadow banking in the United States was worth $10.5 trillion, more than the total value of funds circulating in the conventional banking system. Just like conventional banking, shadow banking creates money without creating any new wealth. As well as its activities being unjust to the point of fraudulence, shadow banking is deeply culpable.
“Instead of kowtowing to the financial sector, governments should be acting in the interests of all citizens.”
The motivational framework for banking and the bonus culture also need to change. If profitability and bonuses are linked to making loans by creating new money then, instead of helping to generate real wealth, banks will continue to undermine the real economy. The simplest way positively to re-incentivize and reconfigure the commercial banking system is to remove from it the ability to create money. Commercial banks should also be stripped of the subsidy they receive from central banks when new ‘base’ money (notes and coins) is issued. Why should privately owned commercial enterprises get first and essentially free use of new money created by government?
In the 1960s, when UK banks were subject to proper regulation, the split between government-issued money and money produced through fractional reserve banking was about 50/50. During this period, not only were adequate cash reserve ratios in place and adhered to, but the central bank would also make requests to commercial banks to limit credit creation if the money supply looked to be getting out of control. Aware of their responsibilities to wider society, the banks did as they were asked. In a democracy, the role of the state should be to take whatever measures are required to promote equality of access to economic opportunities. This means regulating the banking system so that money serves its proper function of supporting the real economy, rather than the real economy being sacrificed to the selfish interests of the money men.This may all look like a great deal of regulation, but history shows that economic stability and inclusion are dependent on the regulation of the banking system to ensure a stable money supply.
Whatever method is adopted to ensure money supply stability, it is clear that the rules around it need to be properly enforced. It is the responsibility of democratically elected and accountable governments to do this, and it is in everyone’s best interests. Leaving the money supply in the hands of profit-motivated bankers is a recipe for continued instability and economic exclusion. Mayer Amschel Rothschild’s famous nineteenth-century quote is disturbingly relevant today: “Give me control of a nation’s money supply, and I care not who makes its laws.”
Excerpt from Four Horsemen: The Survival Manual.