Sir Mervyn King, Governor of the Bank of England, gave a speech yesterday afternoon. Most of it was unremarkable, but the following paragraph is worth highlighting:
Smaller and medium-sized companies (SMEs), however, are constrained to borrow through the banking system. And there is special concern about their ability to obtain credit – I share that concern based on my experience of meeting many such firms during visits to all parts of the United Kingdom and hearing reports from the Bank’s regional agents. We have made this point repeatedly at hearings of the Treasury Committee in Parliament. Over the past year the stock of SME borrowing has shrunk by around £5 billion or 5%. By far the most effective way of helping SMEs quickly would be to provide incentives for lending by existing banks because they can assess credit risk in a way that no other institution could do in the immediate future. Bank and Treasury officials are working together on such ideas. In the end, however, the shape and parameters of any scheme will be, and properly so, determined by the Government. [Our emphasis]
There are a few problems with this paragraph. Firstly, the reason why small businesses are constrained to borrow through the banking system is that the banking system is the sole creator (and injector) of money into the economy. If nobody borrows, no money is created – simple as that.
Secondly, my strong impression is that these businesses aren’t trying to borrow to expand their businesses. Instead, they simply need to borrow to stay in business. That’s not an indicator of a need for more lending (i.e. more debt) – it’s an indicator of a need for more money in the economy. This money could be injected into the economy without creating any new debt, by the Bank of England, if it wanted to actually direct money towards the people rather than towards the banking sector.
Thirdly, let’s be realistic about what banks actually do. The idea that they take money from savers and invest in businesses to help the economy grow is a fairy tale. What they actually do is pump over 75% of their lending directly into unproductive property bubbles and speculation on commodity and foreign exchange (according to Bank of England figures).
Finally, incentivising banks to lend to businesses might stop a few of them running out of cash and going bust. But no business can expand when consumers don’t have any money to spend on the things that businesses sell!
Very simply, rather than repeating Quantitative Easing to pump yet more money into the internal system that banks use to pay each other, the Bank of England should pay money directly to citizens, who can then spend it in the very businesses that are ‘constrained to borrow from banks’. This will bypass the banks and get money onto the high-street where it will actually help to support small businesses and grow the economy.
This is basic stuff. I’m at a loss to explain why Mervyn King and the others at the Bank of England believe that pumping more money into the financial sector will help the real economy. In fact, in the same speech he admits that the money will effectively ‘slosh around’ in the financial sector and expresses a vague hope that it might actually get to real people at some point:
When the Bank buys assets, the people who sell the assets to us receive money which can then be used to buy other assets. In turn, the sellers become buyers of other assets, and so on indefinitely as the money is transferred from one account to another. The prices of assets that investors choose to buy go up, raising wealth and pushing down on yields. Those yields are the opposite side of the coin to the borrowing costs of companies. In these ways, the Bank’s purchases of assets increase demand in the economy. [our emphasis]