A Breath of Fresh Air in Conference on Banking

I recently attended the free public session of The European Conference on Banking and the Economy (with the tagline “Banking: seeking a new paradigm”) hosted at Winchester, birthplace of the English tally stick system.

The two main speakers at the free public session were Lord Adair Turner (both Financial Services Authority and Committee on Climate Change chairman) and Prof Richard Werner (of the University of Southampton’s school of management). I’ll give you my summary and impressions of what each of them said.

First Prof. Richard Werner, who was a breath of fresh air. It’s heartening for “cranks” everywhere to see an Oxbridge educated economics professor stand up at a conference in a suit and tie and state that:

“It is basically an accounting trick … Banks create money. They don’t lend it … When a bank gives out what is called a loan, it basically pretends that you have deposited the money… it has to invent the liability … This is how the money supply is created.”

(please bear in mind that the above and indeed all subsequent quotes might not be quite verbatim – I was making my own paper notes in a hurry!)

In response to an audience comment that the entire financial system is dynamically unstable, as it is impossible to pay off principal plus interest when only the principal is created, Prof. Werner replied that it is in fact possible, instead stating that for him:

“The biggest source of instability is the use money is put to. Banks are not just creating the money supply, they are also the decision makers. They decide who this money will be given to.”

Prof. Werner then went on to say that local banks will put money to more sustainable uses, since they are not interested in “lending” it to hedge funds, speculators, the derivatives market etc. In an earlier talk, we learnt that the German banking system is much more locally based. Prof. Werner stated that in the UK around 90% of deposits are in five major banks, whereas in Germany this amounts to only 14-15% with the rest of people’s savings placed in local banks, in which “the staff have known customers since they were children” leading to a “very different incentive structure” to that of the commercial high street banks.

Also discussed by Prof. Werner in response to an audience question was, should interest on money (or “usury” to give it its historical name, as Prof Werner was bold enough to do!) be charged at all? Prof. Werner then stated that the Babylonians invented both the concept of interest and a solution to its inevitable drawback – the excessive concentration of wealth over time. Their solution was to clear the backlog of debts that built up every few decades. An option I feel should at least be on the table today, in light of an ever ballooning Euro-zone debt crisis.

Prof. Werner was also remarkably candid about the intellectual disgrace at the heart of the economics profession: its near total suppression of “dissident” thoughts. He described “journals I am forced to publish in” (!) that will not allow the submission of academic papers mentioning the role of credit creation in the economy, stating that “if you try to publish in these journals, it is a taboo word.” one “virtually banned from the so-called leading journals for decades”.

And this suppression of an inconvenient truth apparently extends all the way down to undergraduate economics teaching. Here is an absolutely mind-boggling quotation Prof. Werner lifted from one of the most widely used undergraduate economics textbooks:

“Including money in the models would only obscure the analysis”

I suggest reading the above quote several times, to fully grasp its koan like properties! Its deployment prompted a great deal of spontaneous laughter amongst members of the audience, including myself. This is an issue Prof. Steve Keen of the University of Western Sydney often raises, but I still find absolutely incomprehensible – models by professional mainstream economists do not include money, debt or banks!

Prof Werner’s answer to the Queen of England’s question to economists “Why didn’t you see this coming?” was “Because they didn’t have money in their models!”

There was also an interesting story about Alan Greenspan, who apparently wrote an economics paper in 1967 discussing Credit Creation. He later went to work for the US Federal Reserve. Prof. Werner used the Reuters search engine to look for “Alan Greenspan” and “Credit Creation” appearing together in any speech made on behalf of the FED. The result? ZERO hits. No doubt in such an official position it is smarter not to raise awareness of a process most of the public would be opposed to, if they actually knew about it!

A point also suggested by Prof Werner’s discussion of the answers he received to two monetary questions addressed to the public. First question:  “Who creates the money supply?” to which an overwhelming majority responded “the government”. Second question: “Would you be in favour of a system where commercial banks create the money supply for private profit” (i.e. the system we have!) to which the overwhelming majority responded “No!” (with some apparently adding “Are you crazy?!”)

——

Now I move to the other major speaker at the conference, Lord Adair Turner. After listening to him talk, I did not have the impression of a man “seeking a new paradigm” as encouraged by the conference title.

My impression was that of a man seeking to patch up the old paradigm – by making the minimum concessions necessary to prevent the mob descending upon HSBC headquarters with flaming torches and razing the building to the ground! I had the sense of a man adapting to changing surroundings in order to survive. If Lord Turner were an animal, he would probably be a chameleon.

Lord Turner “communicated” via an habitual and obtuse econ-speak, requiring a good deal of audience focus to translate in real time back to English: particularly during a talk ostensibly made for the public. Amongst the sentences I successfully extracted some meaning from, statements abounded which I suspect he would have felt quite unmotivated to make prior to the financial crisis. Here are a couple of typical remarks from his talk, on the subject of what the financial crisis has taught “us”:

“We have excluded any consideration that regulators might allow more socially valuable allocation than the banks might allow” 

“We now know that financial complexity is not axiomatically beneficial”

Apparently, it is only professional economists – the “we” presumably being addressed in the above remarks – that did not know these things prior to the financial crisis. Widespread public or dissident knowledge contrary to the above dogmas of mainstream economics received no mention in Lord Turner’s talk.

There were however some token references to Irving Fisher’s Debt Deflation Theory and Hyman Minsky’s Financial Instability Hypothesis, currently being rediscovered by many economists in light of the financial crisis. Curiously though, Fisher’s proposed 1935 solution to a debt deflation crisis, 100% Money, was not considered worthy of mention by Lord Turner, who did however see fit to remark that full reserve banking would be “politically unrealistic”.

A most interesting remark, given that Prof. Werner’s earlier public “questionnaire” indicates the overwhelming majority of the public would be in favour of it! I struggle to imagine Lord Turner ever dreaming of bringing up these names and topics in a conference address a few years back, a point he practically acknowledges himself here (from around 11:00):

“I think if you go to the insights of Hyman Minsky and others, you understand that there is something about credit extended against assets that have replacement value, above all against real estate  …  they can simply get locked into cycles where the very process of extending credit is generating an asset price increase, which is therefore appearing to validate the extension of credit, encourage even more extension of credit, but is also generating profit on bank balance sheets which appears to be generating the extra capital which makes the credit extension possible. And I think we have to understand these cycles … Now what is interesting is,  what I’ve just said, if I’d said it five years ago people would have thought I was just a complete heretic against the sort of religion of the time.”

Apparently, Lord Turner accepts that asset inflation bubbles are theoretically as well as empirically possible. I presume he kept such revelations to himself while he was vice-chairman of Merrill Lynch Europe from 2000-2006, immediately prior to the firm’s significant implication in the 2007 American sub-prime mortgage crisis.

While I agree with much of what Lord Turner is saying now, as far as it goes, I feel we ought to ask ourselves: Why is he only saying it now? One wonders about the motivations of a man that will not speak the truth while it is personally inexpedient to do so, then speaks it with an air of divine inspiration the instant circumstances change to make this truth more palatable. A chameleon indeed. I say we would do better with a lion or lioness as FSA chairman – any man or woman who stood in plain sight and bravely roared the truth long before the financial crisis. The list of applicants would not be very extensive – heretics are mostly excommunicated in the religion of economics, as Prof. Werner informed us earlier.

The conclusion of Lord Turner’s lengthy talk, in which a lot was said but very little communicated, was that perhaps “we” should significantly increase liquidity and capital adequacy ratios in some sectors of the economy. Or on the other hand, perhaps “we” shouldn’t, as this might have the drawback of stifling the initial economic recovery (I feel one would search a transcript of Lord Turner’s speech in vain for any definitive policy statement whatsoever, or indeed for any hit of the “paradigm shift” needed to prevent recurrent crises). This particular issue “is very complicated” apparently. A lot of things in Lord Turner’s talk were “very complicated”. In a free public session, the message subliminally communicated by Lord Turner was for the public to steer clear of dangerous topics like monetary reform, which are far too “complicated” for them to understand, and as such are best left up to “experts” such as himself to “fix”.

For me, this was the key difference between the two men. Prof. Werner appears to desire an educated and engaged public that will strive for the comprehension and democratisation of monetary policy: he made any opaque financial matters crystal clear upon every opportunity given him to speak. Lord Turner was continually stressing to the public how “complicated” this money business is. We need more people like Prof Werner, willing and able to make the public a part of the banking reform process. When it comes to the current banking reform situation, to say the foxes are guarding the hen-house doesn’t quite capture it. Rather, many of the foxes are currently being commissioned by our government to design the next generation of fox-proof hen-houses!

An excellent summary of our predicament came in the form of a very insightful audience comment from a lady wearing green sat a few rows in front of me, whose name I unfortunately didn’t catch. She summarised the financial system as containing “massive conflict of interest” leading to “total systemic failure”. She described economists as being “always behind the curve” in addressing crises. Prof. Werner strikes me as representing the very few economists ahead of the curve, Lord Turner as a representing the many more self-servingly behind it. Whether this “total systemic failure” can be addressed though the existing channels or not will depend upon which group is listened to.