Time to halt this ‘insane’ system

From: Peter Verity

Sheffield S11

Many expl anations have been given for what triggered the recent ‘credit boom’ and ‘credit crunch’, such as sub-prime lending and international trade imbalances. However, the root cause is surely the nature of credit itself.

How do the banks work? According to polls, most people believe that the money banks loan out to borrowers comes from the money deposited by savers. In fact, the truth is more sinister. Our system of ‘fractional reserve banking’ gives commercial banks a licence to literally create money out of thin air – and then charge interest on the money they created. At the height of the boom, banks created £44 “credit” for each £1 of deposits!

Now, the economic health of the nation – people’s livelihoods and jobs – depends on the availability of money to oil the wheels of commerce, yet we allow commercial banks, driven purely by the interests of their shareholders, to determine how much or how little money is in circulation. Could you invent anything more insane? For example, in 2008, the banks created £266bn of new credit when it was profitable for them to do so, fuelling an asset bubble. The following year, when lending became risky, this fell to £106bn – a massive £160bn fall. This drastic reduction in new money supply was a root cause of the recession, leading to thousands of job losses.

Fractional reserve banking is also the cause of spiralling debt. When a bank lends £100, it expects (say) £110 back the next year. Where does the money come from to pay the interest? Since ALL money is created by the banks, they have to keep on creating more and more to cover the interest payments – in effect, the money they create each year is the following year’s profits! And since all money is created as debt, this means that we must get deeper and deeper in debt year on year. Total debt to the banks now stands at over 2 trillion pounds and is increasing exponentially. There is no escape, it is a mathematical certainty.

We might blame bankers for many things, such as irresponsible lending, and obscene bonuses. However, they cannot be blamed for the system which they have inherited, that can only be changed by political will. I believe that the modern banking system is flawed in its foundations; the faults lie so deep that we are blind to them. No amount of tinkering at the edges can make right a system in which money supply is controlled wholly in the interests of bank shareholders.

It doesn’t have to be like this. A number of economists, including the New Economics Foundation (nef), have called for an end to fractional reserve banking. They recommend implementation of a ‘full-reserve’ banking system, and have submitted a proposal to the Independent Commission on Banking (ICB). In this model, the licence which allows commercial banks to create credit is removed. Banks can only lend out what has been deposited, so they cannot trigger a credit boom or bust. The money supply is controlled solely by the central bank, free from both commercial and political pressures.

Money supply would be much more stable, and it could genuinely bring the end of boom and bust. In addition, the spiral of ever-increasing debt could be broken as, when new money is needed, it could be injected directly into the economy instead of being created as debt. The existing debt burden could be gradually paid off without creating more debt, avoiding another crisis and another round of spending cuts.

A public campaign has started to end fractional reserve banking, and I recommend readers to look at the positivemoney.org.uk website which explains further, and which has the submission to the ICB in downloadable form. Needless to say, the banks will fight tooth and nail against it– the campaign needs your support.