This is from Martin Sandbu in the FT, just published:
Recall that the conventional story in which banks merely channel existing funds from savers to those with investments to finance is wrong. As the Bank of England has taken upon itself to explain to the public, banks create new money in the form of deposits when they issue loans. So the demand for loans is the practical constraint on credit and money growth. But credit availability itself fuels that demand: the more banks lend, the stronger the demand for loans – and banking profit being largely a matter of volume, profit-maximising banks will lend where the demand exists. This is why banking is an inherently unstable and destabilising activity.
But it also means that unequal access to credit is self-reinforcing. Profit-maximising banks will pour more lending into sectors or places that already have plenty of it, and stay away from those starved of credit. This is a market failure inherent to banking.
And that is why financial capitalism is not sustainable. Not now. And not ever.
But I am not convinced that means some other forms of capitalism within a mixed economy cannot be otherwise.
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There is an excellent paper by Richard Werner in the ‘International Review of Financial Analysis’ 46 (2016) 361—379; titled ‘A lost century in economics: Three theories of banking and the conclusive evidence’. In my humble opinion it is a ‘must read’. It is also interesting on the relationship between accounting and economics; and even more important, the need for experiment in economics; applied economics if you will. Economics, it seems (and it seems strikingly obvious to me), has become essentially an arid exercise in theory, without sufficent tests of the data, methods or theory.
I was asked by a colleague recently if I was allowed to question economic theory in a draft paper we were discussing
Kind of worrying
Sure as heck we are allowed to
The paper is backed up by experimental data. Not available yet though….
That is worrying. It rather makes the case. I look forward to reading the paper, when published.
Incidentally, Werner’s paper makes a point of following through to an empirical “test” of the three theories (fractional reserve, intermediary, and credit creation theory) in real world banking transactions: Section 3.2 The Test (examination of banking transaction). Werner concludes the test by examing which theories actually reflect reality; which I have foreshortened to the final implications, as follows:
(Section 4.2) “Thus the accounting representations of both the fractional reserve
and the financial intermediation theories of banking, whereby each bank
is considered an intermediary, are deeply flawed: either each lender is
a bank and hence able to create money due to the very fact that it
does not have to hold client funds outside the firm, or the firm is a financial
intermediary and not a bank, in which case the client funds do not
appear on the firm’s balance sheet at all.
….
Given the above analysis we can confidently say that the fractional
reserve theory of banking in its textbook application, including the
‘money multiplier’ approach, is wrong. This may explain why it has
been quietly dropped in textbooks over the past decade or so.”
Werner concludes, “It is found that the credit creation
theory of banking is consistent with the empirical observations, while
the other two theories are not.”
I’ve read Werner’s ‘Princes of the Yen’ and there is no doubt in my mind that the man understands the State’s role in macro economics and is fully aware of the snake oil that is American neo-liberalism.
Thank-you for linking to this paper – I’ve mentioned Werner’s work on this blog a few times and feel that it has fallen on deaf ears. Bank money creation and the theories of banking really need to be addressed by MMT theorists before I could fully support their theory and Werner’s work is a good place to begin.
This might be helpful – https://www.youtube.com/watch?v=QyzKblOtZjg&feature=youtu.be
Steve Keen has the same reservations as I do regarding MMT’s consideration of private banking – but he is much more proficient at communicating the point
Thanks for this
Reposting on the blog tomorrow
I’m not quite sure I follow the logic here – although I can’t access the full piece. I’ve put down my thoughts about banking here in response to Ann Pettifor’s book. We need to change the motivation of banks. http://www.futureeconomics.org/2018/01/the-production-of-money-how-to-break-the-power-of-bankers-by-ann-pettifor/
From following these pages and other reading concerning MMT it would appear that upwards of 95% of money is keystroke created by the banks. Could not a government with political will just not rein in this profligacy and demand control over money creation? We always hear that government created money is inflationary and will lead to Zimbabwe, post WW1 Germany type scenarios but private banking created money has led to unaffordable housing. Why is one acceptable and the other unacceptable?
It could, yes
MMT offers a variety of ways to do that
It’s not just controlling the money supply though: tax is also in the mix
Not all money is bad, remember
I realise not all money is bad but I haven’t moved house since 1975 so I haven’t been affected by house price inflation. BUT the money that has inflated house prices could have been used for infrastructure.
Rod, to what extent is house price inflation due to the banks though, as opposed to successive Governments deliberately privatising social housing and and refusing to build anywhere near enough provision, whilst continually enacting measures to boost house prices and allow private landlords to rake it in?
In other words, whilst the banks are fuelling the credit side of the equation, the Government are deliberately stacking up the demand side of the equation. A radical social housing program (on the scale of the post war social housing program) could remove a lot of the demand and thus sidestep the banks in that sense.
The greatest challenge that private banks create in a free society is one of regulating them to ensure they operate for the benefit of society as a whole, and not just in the interest of shareholders, who may reside in a completely different country, or just not care about thier own.
However, the real problem is that we have come to rely on commercial banks as our only source of capital. This creates two huge gaps in the economy :
1) Public funding for infrastructure with very long term paybacks, plus pioneering investment with highly uncertain risk profiles
2) Micro-financing for the poorest members of society who don’t have access to commercial bank finance
The mechanisms for both these sources of funding has been badly under researched. Consider the risk profile of Fanny May and Freddie Mac, where the US government still stands behind $6 T of loans (30% of US GDP) which are not backed by capital, or the farce of PFI in the UK where ideological objections to public debt resulted in bigger bills for tax payers to pay for essential infrastructure. At every turn it seems the tax payer ends up carrying the risk while private companies walk away with the profit. But still economists have failed to come up with better models for funding public finance.
At the other end of the scale, individual citizens are denied access to commercial finance and forced into the hands of payday loan companies and loan sharks, with no proper legal protections. One key answer to this of course is the introduction of a basic income, which would potentially make even the poorest members of society credit worthy. However, this needs to be accompained by new forms of community and cooperative finance.
The return of non-profit lenders such as building societies would be a step in the right direction, but we should also be studying models such as the Grameen Bank which has made billions of dollars in loans around the World to people who conventional banks consider a credit risk, yet achieves a 99% plus repayment rate. Muhammad Yunus in his excellent book ” A World of Three Zeros ” makes clear that his model can work just as well in America or Euorpe as it does in developing countries. We just need the vision to see how this kind of individual and community lending, combined with a basic income, could transform local and social enterprise in our communities.
Hmmm….Grameen was not all it seemed to be
Nor is micro-finance as a whole
Financial capitalism is the end phase of capitalism. The cannibalistic, non-productive, rent-seeking, casino phase – unsustainable.
Its predecessor, industrial capitalism, lost the ascendancy as increasing automation met with diminishing rates of return on capital. Demand can’t keep up with “productivity” (mechanisation) gains. Greater equality could improve per capita demand but consumer demand has conceivable limits. Capital can seek faster rates of growth in developing nations but that won’t last forever, the rapid growth rates slow as the developing world moves closer to being fully industrialised.
Capitalism’s inherent dependence on exponential growth is unsustainable in a finite world.
So if you are aware of “some other forms of capitalism” that are not inherently dependent on ceaseless growth then you may be right. I am not as yet aware of what those forms may be.
We won’t be until we find it
If we find it.
Thank you, I have also read that this form of creating money is actually the privatisation of money. Such money is also fictitious – it does not actually exist. Years ago it would be the central government bank that would create money, and in doing so such money is public. Such money would actually exist, ie it would not be fictitious. This has been sighted as the main reason for the huge wealth inequality. Most money nowadays is the fictitious private type, created from pressing a button on a computer screen. Very little is real public money.
Paul
I think you have a quite a lot of reading to do
You are missing the fact that all money is backed by government guarantee
And the only guarantee is that it will be taken in payment of tax
‘But I am not convinced that means some other forms of capitalism within a mixed economy cannot be otherwise.’ contains 4 negatives, ex- and im-plicit.
So it is hard to identify the point you’re making – could you spell it out in Basic English please? I’m sure you have many readers whose first language is not English and can’t understand the English preference for complicated multiple negatives when plain writing is what is wanted.
Apologies
I try
But you try writing as much as I do and getting all the sub-editing right
Does this mean that some other forms of capitalism must be as have the same defect? No.’