Accountability for the banks?

While fears about the economy continue to grow, the latest news from the Reserve Bank down here in Australia is that inflation may limit the interest rate dropping for the next few months.  Inflation is apparently an indication that we’re spending too much, so higher interest is supposed to limit that spending – but is it that we’re spending too much, or that banks are giving us too much to spend?

When Governments started printing money, it was based on the gold standard.  They had to have stocks of gold to offset the amount of money they poured into the economy – checks and balances were in place.  It was important, because if too much money got printed, inflation started pushing prices sky high as the value of money went down.  It’s happened elsewhere before, and it’s only a few weeks ago Dilbert had a cartoon series on it.

But banks and financial institutions have the capability to do more than print money.  They create it, out of nothing.  It’s called “credit creation” and basically if you deposit $100, then it’s lent to someone else, at 10% (I’m just using handy figures here), then those repayments are lent again – not only does the bank now have the extra $10 they’ve charged someone for borrowing the money you deposited, but more again from the next lender, and so on.  Technically they could end up with their accounts showing that they have people owing them $900 or more from just that $100 you lent them.

Where are the checks and balances?

In Australia, we currently have no reserve requirement limiting how much that money can be re-lent, so there’s theoretically no limit to how much credit can be created.  Obviously, from the point of the view of the bank, that’s a good thing.  Of course they’re going to want to lend money to as many people as they can, because it means they can go on creating more profits – even if some of it’s never paid back, they still end up well in front.  The only possible check is that if people like you or I walk in and ask for our money back they have to give it to us – and they’ve even limited that so that if we want more than a certain amount we have to give them time to come up with it. They have to consider how many people are likely to ask to withdraw money before they commit it to loans elsewhere.

That’s important, because the amount of money ‘held’ in banks and institutions is many multiples the amount of cash that’s ever printed.  If everyone came in at once, there’s just no way that it could all be paid back.  They operate largely on the faith people have that they are able to keep your money safe and that you can get it back at any time.   That’s why everyone’s desperate to prevent that ‘run on the banks’ from happening, because if that happens then we’re likely not only to lose faith in the banks, but possibly in the monetary system as well – which also operates on consensus agreement as to value.

Remember, it’s not that the money doesn’t exist – it does, but only so long as we all agree to believe that those numbers in our bank account are the equivalent of the amount we’d hold if we withdrew it.  That’s why the current fears about bank collapses are critical issues.  In fact, money itself is the same – the vast majority of it doesn’t have any physical form, (unless you count the card you use to access it) and it only holds the value we all agree to give it.  This belief flows on down to every system that depends on it, banks and shares included.  Most people don’t have the same fundamental belief in the value of shares, for example, as they do in banks, which is why their value is much more volatile.  The trouble we’re having now is that, having over-exploited their ability to create money, that sense of security associated with banks has been devalued in our eyes, and we’re starting to question how safe a guardian that system is, in watching over our money.  That increased sense of risk about banks is undermining the faith that lets them do business.  If that faith disappears, if enough people no longer believe that the numbers in their bank account mean anything, then you get that ‘run’ on cash – and like I’ve said, there’s never been enough cash to cover all those numbers, so a whole lot of money disappears with the bank.

(Fortunately, from what we’ve been told over the last few years, most Australians have far more debt than savings, so if those numbers disappear, and we no longer have a bank to owe money to, we end up better off!  Even in a worst case scenario, if the ‘creditors’ took my place to sell it, in this market I could probably buy it back for less than I still had owing and end up coming out ahead…)

I’m working on another post on how to avoid the panic and fear that’s going to cause a lot of people so much anguish in the times we’re going through, because the more widespread that fear becomes the worse the economy will get – remember, the economy hasn’t changed, only how people feel about it.  But meanwhile I’d like to pose the question: is there anyone out there that can explain to me why inflation is being targeted through addressing symptoms (spending) rather than root causes?  Why aren’t governments looking at re-creating that faith in the monetary system through regulation of how much credit creation the banks and financial institutions are allowed to do?  Australia used to require deposits of a certain percentage of their holdings with the reserve bank, I believe, but it seems that disappeared – I can’t help but wonder if that was just before we started getting the rampant over-lending that led us where we are today?

I’m not an expert, but it seems to me that the end consumer is copping it both ways, and most of the anti-inflation measures don’t stop the financial corporations flooding more money into the lending market, but slap consumers (who are already doing it tough) on the wrist for accepting it!

Anybody?

Tagged as: banking, credit creation, fault, inflation, recession