(George Osborne Take Heed)
Ireland may now be in the ‘death spiral’ that is a natural end result of fractional reserve banking.
Here’s the death spiral in visual form (click on the image to enlarge):
Like the UK and nearly every other country, Ireland has given the power to create money to commercial banks and given the banks a monopoly on the distribution of this money so that the public must borrow it from the banking sector. To maximise profits, banks lent as much as they possibly could, inflating the housing market. This sucked in many who were lured by the chance of getting rich quick, as well as pressuring the young to ‘get on the ladder’ before housing became completely unaffordable.
Eventually, this increased housing debt became too much for some households to bear (in the recent crisis, it was the sub-prime American families that broke first). These defaults reduce the assets side of a bank’s balance sheet, making the banks technically insolvent.
Now, at this point it would be tempting to allow those banks to go bust. However, allowing bad banks to go bust is actually the most expensive option for the government.
This is because most governments offer deposit insurance – the guarantee that even if your bank goes bust, the government will reimburse you. This deposit ‘insurance’ doesn’t work like a normal insurance scheme, where the money is waiting somewhere to be distributed to whoever is unlucky enough to be in the car crash or burglary. Deposit insurance schemes generally levy a trivial amount from the banks, and get the rest from taxpayers. In the UK in 2008-2009, the deposit insurance scheme levied £171million from the banks, and collected the shortfall of £18.9 billion from taxpayers – that’s an average cost of £440 per UK adult.
However, the major problem with deposit insurances is that it guarantees that governments will always end up bailing out banks that should be allowed to fail. As long as deposit insurance is in place, if a major bank becomes insolvent then the government has a choice of either:
- bailing out the bank directly with a few billion pounds (or Euros) so that, on paper at least, they are no longer insolvent, OR
- letting the bank go bust and re-imbursing every single depositor, at a much greater expense.
With those choices, bailouts are always actually cheaper than simply allowing the bank to go bust.
Inevitably, this leads to a taxpayer-funded bailout, which increases the national debt, requiring tax rises and spending cuts.
This reduces household income (more tax, fewer public sector jobs, less spending in the economy), making it more likely that more people will default. This second wave of defaults will push the banks back into insolvency (which is why €25billion of Ireland’s bailout funds are earmarked for future bailouts). The further increased national debt that this generates will require even further spending cuts and rising taxes.
Where Does This End?
It’s hard to say how a country can get out of this death spiral. My own view is that there may not be a way out under the existing system, and that what we are witnessing now is the dying days of a system based on fractional reserve banking.
The questions on my mind right now are:
- Have the authorities realised that it’s over, or do they still think they can ride out the storm if they hold on tightly?
- Do they still believe that fractional reserve banking is a good foundation for the economy, and that it only needs a few thousand extra pages of regulation to hold it together? Or are they starting to suspect that the very foundations are flawed?
- Just how much capacity to bail countries out does the ECB and the IMF actually have?
- Would they like to talk to us about the solution now, or wait until they’ve missed the boat?