Why we need banks

People are angry – you can understand that.  They see that the problems have largely been caused by the banks and are saying – hey let’s return to full reserve banking where a bank has to have all the money before lending it to you. That way there can’t be any problem. Others are saying – hey we don’t need banks. Just look where they’ve got us!

I understand these positions and have some sympathies. But I want to consider the effects of either of these two.

Suppose banks couldn’t write loans unless they had all the money. Let’s assume that the Central Banks do not print money willy nilly so consider to start with the definition of money.

It is, in effect, a means of storing your labour. People say that time is money. No, money is time – or rather time multiplied in some way by what is called value, which is a rather nebulous concept since the value is dependent on the market worth. We can go round in circles on this one or I could write a whole load of equations down filled with integrals and the like.

So an example. You dig a hole in the ground for a farmer and get paid. The farmer can’t sell the hole in the ground so it is not valuable even to the farmer next door. It only has value to the farmer and he needs it for drainage – not to have it would mean his livestock would die. End of.

If you take the money you have earned to the market and use all of it to buy food, some of that food may rot before you can eat it.  So you use a bit to buy food and keep the rest somewhere – under the mattress, in the bank, wherever. Maybe you pay some rent, buy some shoes for the kids etc. Either way, the money represents your labour which you turn into goods and services over time.

Inevitably two things happen. Firstly the hole you dug fills with water because it rained afterwards or some such event which means that your work was not perfect so it may have to be drained or re-dug. Secondly the food you buy is also imperfect and you end up wasting some of it, your kids wear out their shoes. You see the way this is going? Once you spend the money, you can’t get it back. Just as work is not conserved and is not reversible, neither is money. The world is full of people who imagine that money is some constant. It never has been and it is always being wasted. Get used to the idea.

Therefore to promote economic activity, money needs to be created all the time or the economy stagnates. This is just to cope with the continuous waste of money.  It is as if money is a bastion against entropy – that process which is always increasing and is a measure of disorder. If we do nothing, the bridge will fall down. Where does the incentive to keep the bridge repaired come from? Unfortunately we cannot do it just for love – it doesn’t feed our family or put a roof over our heads so we would go cold, hungry and soon die. No, we do it for money.

As a society we have to do work to keep going. Maybe we do too much these days and live on the high wire. But doing too little is more dangerous – society will stagnate.

The upshot of all this is that money needs to be created continuously. A mechanism for this – perhaps not the only one and clearly not perfect – is fractional reserve banking. This means that there is discipline that work will be done and that the lender is solvent enough to be able to create the money in the first place – that enough real cash is available if required for people to hold in their hands.

Full reserve banking is a recipe for recession, stagnation, deflation and everything that goes with it. Worse, as it implies a conservation of money, it means there is little room for newcomers and most money will remain inherited. There will be no abundance, no room for the entrepreneur who creates wealth, no room for new ideas and work.

In the same way, doing away with banks is just an extreme version of full reserve banking. You can use credit unions, Zoppa, building societies, or store your money under the bed but none of these can generate the money that will rebuild that bridge, educate your child or otherwise make for progress.

Because, by agreement, only banks can create the money. This is the hold they have over us. As a society, we need to have a hold over the banks, which is why I have proposed the Three Taxes so that they pay for this privilege. We needed this hold years ago but hey – it’s not too late!  D’you want to let them get away with another hundred years of plundering?

15 thoughts on “Why we need banks”

  1. Money is simply a median of exchange. I like the way you refer to it as storing your labor. Loans are borrowing against my future labor so that if I don’t work, I can be in big trouble and unable to pay back what I owe.

    1. Thanks for the comment @CMF. But that’s the problem. Loans turn time into money but to repay them, you have to be sure of turning money into time by your rate of exchange.

      One answer to your conundrum is to take out insurance. The actuaries turn the handle, do some (almost certainly imperfect) sums based on further guesswork, and all of whose time is paid for by you. And when you don’t fall ill or lose your job etc, you can’t recover that money because the actuaries have had their holiday, schooled their kids etc.

      But if the worst happens and you do fall ill, the insurance companies will have a field day paying even more people to find a good reason why they shouldn’t pay out.

      Fun, ain’t it?

  2. The U.S. has fractional reserve banking now. the Federal Reserve Bank in the United States acts as a regulator and oversees fractional-reserve banking. But, that’s not working too well now is it. Our economy can’t handle A Full reserve system. That would be equivalent to the gold standard. Everything will shut down. The only issue I see with the 3 tax system is that the banks will band together to defeat it. Either through government policy or cooperation.

  3. Absolutely @YFS but you have to see the number of people who don’t realise what has been happening – really since the 11th century but most certainly as far as Joe and Jane Public are concerned, since the mid ’80s. Full reserve banking would mean closing down all economies so that the only ones that continued would be those with massive gold or oil reserves. Nice friendly law-abiding places like Russia, the Middle East, Namibia. Well you can throw the US, Canada and Australia in I suppose….

    The banks will undoubtedly oppose the Three Taxes but that doesn’t mean that they will be successful. Their strongest weapon will be to corrupt the politicians and officials. But if that happens we are all dead in the water anyway. No, it would take a degree of political courage which may be hard to find of course.

  4. It is such a balancing act isn’t it?! There never seems to be a clear cut answer. I do like the fact you talk about money as being an exchange. So many people forget money is a give and take thing, not just a taking thing. This is why they end up in trouble.

    1. Yup. The important thing is that because there is always waste (no such thing as a perfect machine and reversible work – if there was we would be able to time travel and wouldn’t that be fun!) you have to keep on creating money. It just needs to be regulated in a way that is not centrally controlled but also not the gambling party we have recently seen!

  5. We definitely need central banking and we definitely need a fractional reserve system. That being said, there are a couple of obvious things we can do to lessen our exposure to another economic collapse going forward. First, banks can’t be leveraged 30-1. That’s just crazy. Also, we should separate investment banking from deposit banking again so there is just less risk in the whole system. Finally, and most importantly, we need to have some anti-trust laws, especially in the USA, to ensure good competition amongst banks. Right now the “too big too fail” problem basically guarantees a long-term license to gamble with everything (aka moral hazard).

  6. The leveraging of Lehmans was between 60 and 80 when it collapsed.

    When Dubya said – let the sucker go (well that may not be accurate as I wasn’t there) he clearly didn’t understand the implications. What is more surprising is that other people in the room didn’t understand either – or thought it wasn’t important. As a result $8 billion was taken out of the London market over the weekend which had been swept back into New York on the Friday evening in the expectation that it would be sent back on Monday. It wasn’t.

    PWC had to work all weekend to bankrupt Lehmans London or the whole financial system would have collapsed that weekend. Literally – the whole world, not just London. Folk don’t always appreciate how close some things came.

    The effect was almost a disaster when added to a precarious situation where RBS was on the point of closings its cash machines – within 15 minutes is some estimates and had to be taken into public ownership.

    Then you have HBOS, BoA, AIG, etc etc.

    It happened over Thanksgiving of course and perhaps he had other turkeys on his mind.

  7. It’s made round to go’round – or so the saying goes. I often think about where all the money goes, usually when looking at the year to date part on my pay slip. It is always great to keep as much as you can, but loss is inevitable. My method of combating this is to find other ways to ‘create’ more for myself.

    1. @Shaun – the best way is to become a bank of course! Then you can print as much of the green (or whatever) stuff as you want. I wish… 😛

  8. Banks make money on the spread between what they pay in interest and what they earn on loans. Banks were making loans that they knew were risky and sold them as good credit. Making loans without income verification is very risky in the sub prime market. The credit rating agencies said these loans were triple A. This all contributed to the mess.

  9. That’s what they would like you to believe @kc but it is a scam.

    The profit they make is not so much on the spread but on the interest itself. Most of the money is generated. It used to be 97% and now it is down to 90% with Basel 3. So the interest lenders pay is almost all profit. If you have a credit balance, yes they pay interest on that but it justifies them lending 10 times – it used to be 30 times – that amount.

    It is this debt that becomes real money when you pay it back by working. That’s why I say in Funny Money that we all work for the banks.

    I very much agree that the agencies were complicit – they haven’t got a clue what they are doing.

  10. I firmly believe in banks but I also don’t believe in gouging the customer. With BofA recently doing that fee and then rescinding it, they seem to not really know what they need to do to keep their head above water but I hope they figure it out soon!

    1. Hi NwB – good to hear from you!

      It is curious when institutions like BoA, RBS, UBS etc etc (we could go round the world on this one) who have literally a licence to print money manage to lose so much of the stuff. It smacks of complete carelessness and administrative incompetence.

      More on this later …. 😛

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