Very Deep Crisis & Chances of Recovery

The UK economy is “in a very deep crisis”, Business Secretary Vince Cable has told the BBC. He said predicting when the economy would recover is “very difficult”.

“We are in a very deep crisis, quite unlike any we have experienced before because its centred on the collapse of the banking system.”

“We are overcoming problems with a massive government deficit, difficult broken banks, levels of personal indebtedness. Projecting and predicting how we get out of this crisis is very difficult indeed.“

We hear similar statements about the global economy too:

IMF warns: No recovery until 2018, according to Guardian, Wed 3rd Oct 2012

IMF chief economist Olivier Blanchard

The IMF’s chief economist Olivier Blanchard says global economy will take a decade to recover from the financial crisis

The International Monetary Fund’s chief economist has warned that the global economy will take a decade to recover from the financial crisis as the latest snapshot of the UK economy suggested that growth in the third quarter will be at best anaemic.

And we see more and more protests across Europe:

Tens of thousands of Spaniards and Portuguese rallied in the streets of their countries’ capitals on Saturday to protest enduring deep economic pain from austerity cuts, according to NBC News.

In Madrid, demonstrators approached parliament for the third time this week to vent their anger against tax hikes, government spending cuts and the highest unemployment rate among the 17 nations that use the euro currency.

Is this all necessary?

As is obvious to most of our readers, and as Mr. Cable confirmed recently, this crisis is centred on the collapse of the banking system.

Indeed, the current banking system facilitates intermittent financial crises and recessions. Between 1970 and 2007 there has been a total of 124 systemic banking crises identified.

Why Are There So Many Banking Crises?

The question is why history keeps repeating itself, despite a multitude of regulatory regimes, from liberal to interventionist. Is there something fundamentally unstable about the modern monetary system?

Our banking system is fundamentally broken, yet for all the millions of words of analysis in the press and financial papers, very little has been written about the core of the problem. While there are many problems with banking, at the root of the issue is that successive governments have ceded to the banking sector the responsibility and authority for creating new money and managing the money supply.

Most money, as used by people and businesses across the world, is created not by the state or Bank of England, but by the private banking sector.

It is not just the structures, governance, culture and incentives of banks that is the problem; it is the fundamental method of creating the nation’s money supply. It is this process of creating and allocating new money that needs fundamental and urgent reform.

Chance for a recovery – Bad news and Good news…

The bad news is that:

“We have no hope of living in a stable economy whilst the money supply – the foundations of the economy – depends entirely on the lending activities of bankers who are chasing short-term profits.”

The good news is:

We do have hope of a recovery, stable economy and many other massive improvements, if we reform our monetary system.

Monetary reform as proposed by Positive Money would achieve:

1. a stable money supply which is not based on debt, not issued by private banks and not dependent on the lending behaviour of banks,

2. an economy where entrepreneurs, innovators and the real economy can thrive,

3. reduce the burden of personal, household and government debt,

4. a structure of banking that allows banks to fail, no matter their size.

The benefits of implementing this proposal for full-reserve banking are enormous. By returning the exclusive right to create money to an independent agency of the state, preventing it from creating money if inflation is rising, and using any newly created money to reduce taxes and fund better public services (rather than simply pumping much of it into an over-inflated housing market), we get a loads of other benefits:

The drastic cuts in public services could be avoided. The reform would completely remove the exposure of the government, and thus taxpayers, to banking crises. It will result in lower house prices, reduced likelihood of house price bubbles and speculation on house prices would cease to be profitable. Full Reserve Banking would lead to many other positive effects on environment, inequality, unemployment, democracy.

Positive Money has a draft legislation for monetary reform that would implement ‘full reserve banking’ in the UK.

[sws_green_box box_size=”630″] In late November Positive Money will release a brand new book that comprehensively describes the proposed reform, all the implications and impacts it will have and the transition process in the smallest details. Watch this space for further info. [/sws_green_box]

Here is a short extract from the new upcoming book:  

Whilst inspired by Irving Fisher’s original work and variants on it, the proposals outlined in this book have some significant differences. Our starting point has been the work, in the year 2000, by Joseph Huber and James Robertson (Creating New Money; A monetary reform for the information age, 2000), which updated Fisher’s proposals to take account of the fact that money, the payments system and banking in general is now electronic, rather than paper-based. Over the last two years we’ve developed these ideas even further, strengthening the proposal in response to constructive feedback from a wide number of people. We have also improved the proposal in response to downright hostile criticism, for which we are equally grateful!

The simple idea is to remove the ability of banks to create new money (or bank deposits) when they issue loans. Although the reasons may not be immediately obvious, the simplest way to do this is to require banks to make a clear distinction between bank accounts where they promise to repay the customer ‘on demand’ or with instant access, and other accounts where the customer consciously wishes their funds to be placed at risk and invested.

Current accounts are then converted into state-issued electronic currency, rather than being promises to pay from a bank, and the payments system is functionally separated from the lending side of a bank’s business. The act of lending would then involve transferring state-issued electronic currency from savers to borrowers. Banks would become money brokers, rather than money creators, and the money supply would be stable regardless of whether banks are currently expanding or contracting their lending.

The proposals may sound radical to those familiar with the current business model of banking, but that our proposals describe the way that most people would assume banks to work today. These proposals can also be implemented whilst keeping most of the current banking infrastructure in place. Indeed, given the lack of other workable proposals coming from the experts and policy makers charged with ending the crisis, we believe this proposal will need to be implemented sooner or later. For the financial health of governments, ordinary people, and the real economy, sooner would be better.

Taken together, the reforms end the practice of ‘fractional reserve banking’, a slightly inaccurate term used to describe a banking system where banks promise to repay all customers on demand despite being permanently unable to do so.