Time to democratise banking?
How should the centre right respond to the ongoing financial crisis? If it is the case that the day of reckoning has merely been postponed, rather than averted, perhaps the conventional wisdom is wrong?
Free marketeers were put on the back foot by the easily made, yet difficult-to-refute explanation that the credit crunch was market failure. It took longer to point to the more subtle truth; markets didn’t cause the credit crunch. Rather they called time on the folly of central banks, which set interest rates too low for too long.
Then we saw private businesses (which we are supposed to support) being given £ billion bailouts (which we are supposed to abhor). Banks have been nationalised. Our opponents talk of a new economic model, with a switch away from free markets towards corporatism.
To resist this, perhaps free market liberals need a convincing critique of what has gone wrong - one that allows an entirely different, market-based public policy response.
The Cobden Centre claims to have one.
According to the Cobdenites, the answer to the banking crisis is not more bailouts for bankers. Nor is it about giving more power to the kind of officials whose management of interest rates got us into this mess in the first place. Instead, they propose honest money and democratized banking.
Today, when you deposit £100 in the bank, you no longer own that money. That allows the bank to lend £97 of your £100 (they still have to hang on to 3%), meaning in effect that £197 of money now exists where there was initially only £100. The person or bank lent the £97 can then in turn lend it on. And so on – the credit cascading through the financial system.
This is the basis of modern banking, and it is known as fractional reserve banking.
But it meant that at the time of the banking crisis, for every £1 of “real money”, there was X33 that amount of credit. Or put another way, there were 33 people in Britain who thought that the £1 of actual money in the banking system was theirs. You can see why queues form outside banks when customers suspect trouble….
Without fractional reserve banking we are told, there would not be credit. And without credit, the entire capitalist system would not work.
Except it is not true, say the Cobden Centre. If one were to amend the 1844 Bank Charter Act and insist that people depositing money had legal ownership of that money, banks would only lend money on if the depositor agreed. There would, in effect, be demand accounts (with no interest) and savings accounts (with interest, normally without instant access).
Banks would still be able to lend credit. But not unless they were pretty confident that they could meet their obligations. Unaccountable bankers could not generate candy floss credit with your money unchecked. All credit would be backed by savings, and 2 + 2 would equal 4. The catastrophically ruinous debt pyramid that seems to spring up each generation or so, wouldn’t keep rising again and again.
Perhaps a nation of debtors and consumers would become savers and producers once again?
Giving people legal ownership of the money in their own bank accounts is hardly extreme or anti-capitalist. In fact, it’s rooted in a pretty conservative idea of property rights. Yet it would have a profound effect controlling monetary policy.
It would also end the conspiracy against the taxpayer that sees government borrow too much, but then use inflation to erode away its debt on the back of our savings.
By allowing money to devalue each year, the state ensures that it is the prime beneficiary of rising economic productivity – poorer families being literally priced out of the market for goods and services they might otherwise have been able to afford.
If you think that the Cobden Centre’s ideas sound kooky, remember that the idea that the state would nationalise the banks would have sounded off-the- wall a couple of years ago. Perhaps when all other solutions have been exhausted, we could do worse than try to democratise banking?
Read more about the Codben Centre's proposal here.
Posted on 9 February 2010 by Douglas Carswell