|
It is only a matter of
time before the global banking system unravels. For those of us planning for life
after such an event, it is time to think what might replace fractional
reserve banks and the paper money that is their stock in trade, but first we
must understand why modern banking is certain to fail.
The seeds of the banks’ destruction lie in the
fractional reserve system, whereby banks lend out many times their capital.
The problem with fractional reserve banking is that if a number of a
bank’s depositors decide to withdraw their money at the same time, the
bank might only be able to satisfy a fraction of the demands. This is the
permanent state of modern banking.
In our hearts we know this, but we have confidence
that bank runs will not happen. In the current financial climate this view is
dangerously complacent. The five to ten per cent of core capital in each of
the large international banks is badly impaired, with these impairments swept
under the carpet by accounting standards designed to conceal the true
position instead of inform creditors. Again, we all know this.
However, it is increasingly clear there will be a
global slump in business activity, as higher inflation kicks in and interest
rates inevitably rise. Banks will face an escalation of bad debts as a result
of higher interest rates that will eliminate much, if not all, of their remaining
capital. Unfortunately, the abilities of governments to back-stop the banks
are now very limited, because of the unprecedented deterioration in
government finances since the first banking crisis.
The international nature of modern banking exposes
even relatively sound banks to risks from bad debt contagion, if not at first
hand, then through interbank relationships that were previously sound. The
collapse of Irish, Portuguese or Spanish banks has the potential to undermine
British, French or German banks, and therefore all their counterparties
elsewhere. There are many chains of risk like this, respecting no borders.
While there is much that can be done out of the public’s sight, it will
be very difficult for governments to foist a second banking rescue on their
electorates, because they have unwisely encouraged everyone to believe banks
and bankers are evil and do not deserve public support. For this reason the
only option central banks have is to continue to flood the financial system
with new money to compensate for the deflationary effects of contracting bank
credit. This new money in the central banker’s mind can be directed to
supporting the weaker members of the banking system, and in the Keynesian
mind, provide vital economic stimulus. But since successive tranches of new
money are having less effect, the amount required continues to escalate.
This is why central banks are unable to stop issuing
paper money, because to turn off or even to restrict the flow of the
money-tap would fatally undermine the commercial banking sector. For this
reason central banks have no option but to deny that inflation is a growing
problem, otherwise they have to stop printing money and let interest rates
rise.
So put simply, the future we face is that the entire
banking system will sink, along with the purchasing power of paper money.
Fractional reserve banking has been with us too long, so we have to consider
what will replace it, having no working knowledge of any alternative. In
doing so, we also have to consider what we want the bank of the future to do.
The original function of a bank was to hold deposits
safely, and facilitate customers’ payments. If a bank lent money to a
borrower, it had to be the bank’s own money and not taken from deposits
entrusted to them by depositors for safe-keeping. It was clearly set out in
Roman law that to take a deposit and then use it for your own purposes is
theft, and that is still true for all of us today, unless you have a banking licence. However, a loan to a bank is an entirely
different thing, because the relationship between the parties is clearly
established. Like any business, a bank can use a loan for its own benefit,
and in the event of the borrower’s bankruptcy the lender is simply a
creditor. It is these two basic relationships, depositor and lender, that get
rolled up into one by fractional reserve banking.
There have been many instances of governments
exempting banks from Roman legal principals over deposits, usually because it
has allowed governments to borrow money in greater quantities. This is as
true today as it was in ancient Greece and Rome, for the Florentine and the
Catalonian banks in the fourteenth century, the Medici Bank in the fifteenth,
the banks of Salamanca in the sixteenth, John Law in France in the
eighteenth, and finally the fractional reserve system supervised and
guaranteed by central banks since Peel’s Banking Act of 1844.
These are just some examples of banking systems
which start off respecting the custodianship of deposits and then sequester
them for their own use. The fact that all this has happened before with
predictable outcomes nails the lie that this time is different, or that we
are now more sophisticated in our financial knowledge. The co-mingling of
deposits, loans and bank capital almost always ends with bank failures, which
is the true precedent for today’s banking outcome. Our banks have
highly-geared balance sheets in uncertain times: these are precisely the
conditions that end with a run on deposits, and because the global banking
system is already under great financial strain, it is hard to see how they
will avoid the mass failure predicted by the history of human behaviour.
The failure of the banking system does not deny the
usefulness of an institution whose function is to look after customer
deposits, but the business model will have to be entirely different. Since
these deposits cannot in future be loaned out, they gain no interest; so
paper currencies that lose purchasing power are unsuitable as a store of value.
The only secure bank deposit system that truly works has to be based on gold
and silver.
This true depository service already exists in
bullion dealing and depository facilities, the model for which is provided by
GoldMoney, based in Jersey[i]. They store
customers’ bullion in secure storage facilities with no bank
involvement. And they offer the further advantage of storage in a choice of
different jurisdictions. With little or no modification to their businesses,
bullion-dealing depositories can provide this facility to a wider public,
allowing customers to access their deposits and make payments without going
through a fractional reserve bank.
For example, assume you employ a local tradesman. To
pay his bill, you get him to open an account with your bullion-dealing
depository, and transfer to him the gold or silver equivalent of what you owe
him. His bill is settled without the involvement of the banking system, and
he has the wherewithal to pay his bills in the same way. It is also possible
to envisage a network of these bullion-dealing depositories settling
transactions for each others’ depositors.
This network could grow rapidly as the payment system spreads.
The advantages of such a system include
self-regulation, because bullion-dealing depositories are not required to be licenced to misappropriate customers’ deposits. And
in the event of a banking wipe-out, customers of these bullion-dealing
depositories will be in a powerful position, because at the outset they will
be the only people able to settle transactions without resorting to barter,
physical metal or Weimar-style cash.
It seems ironic that the greatest danger posed to
personal wealth, apart from inflation, is from respected, regulated banks.
With their demise, and the end of fractional reserve banking, the need for
bank regulation will entirely disappear. Since bank regulation is one of the
two primary responsibilities of central banks, the collapse of paper
currencies will leave them wholly redundant, and finished as institutions.
While advocates of sound money will welcome the end
of central banks, it will nevertheless be important to protect oneself from
the event. A store of value in precious metals held and accessed
independently from the banking system appears to be the logical conclusion.
[i]GoldMoney
was set up by
James Turk, who foresaw the need for a post-banking settlement and bullion
storage facility. It is the only precious metals depository business of which
the writer has first-hand experience. There are others, that may not share
quite the same vision, and it goes without saying that the reader must make
his own inquiries before opening an account with any of them.
Alasdair
McLeod
|
