Recently, Mr. Richard Coulson sent a response to The Nassau Institute to some of the points Mr. John Tomlinson raised in his remarks at a dinner organized by The Institute on 16 November 2011.
Mr. Coulson makes several points which I would like to comment as an economist who was puzzled by the performance of professional economists in the wake of the “Great Recession”. I will quote Mr. Coulson’s comments and present my views below each of them.
RC: First, he gives us, quite properly, a pretty gloomy assessment of what has happened in recent years. But in certain respects he is guilty of exaggerating the gloom. He tells us that all (his emphasis) sovereign debt is now suspect. In practice, this is hardly true – he is wrongly extrapolating from the situation of Greece, Italy, Spain, and perhaps France, whose bonds are hard to sell and command high yields because of their high risk. Germany, the dominant country the Eurozone, is having trouble selling its high-rated bonds at lower yields in recent days, but this is not so much the case with the UK and Japan. And the whole world still regards US Treasury securities as the safest investment available in the economic universe: their prices actually rose and yields fell even after the famous Standard & Poor downgrade last August. Of course, Mr. Tomlinson fears that US bonds too will be part of general world-wide collapse. All I can say is, if that apocalypse should befall us, there is no way The Bahamas (or any other country in the dollar zone) can escape collapse, no matter what banking structure or other financial measures we adopt. We must simply face that we cannot shield ourselves from a total economic disaster incurred in the world’s largest economy – we will go down the tubes equally.
JB: I agree with Mr. Coulson that not all debt should be dismissed, but he is assuming that interest rates for government bonds are exclusively determined by market forces based on the assessment of the risks involved. Central banks implement their expansionary monetary policies by purchasing government securities and thus propping up their prices (lowering their yields). The monetization of government debt (process by which inflation erodes the real burden of government debt provoking a loss to the holders), if subtle and unnoticed, would have the same effect that Mr. Coulson mentions (low yields/high prices). The level of debt of the UK and the US is rapidly approaching unsustainable levels and it seems that they have decide to monetize the debt and are trying to convince Germany to allow the ECB to do the same with European debt.
RC: Second, Mr. Tomlinson proposes radical restructuring of our laws and banking practices as a way to attain self-sufficiency and impregnability from credit risks and foreign pressures. I will return to give this proposal a detailed analysis, as I believe that although well-intentioned it is completely unrealistic.
JB: Let me briefly comment on the role of “unrealistic” ideas or proposals. It is ideas that rule the world. It is how we think the world works that determines our goals and therefore our actions. We are living today in world conceived by ideas of the late 19 and early 20 centuries. So seeming unrealistic is not a reason for dismissing any idea. If it spreads and reaches a certain tipping point it will generate human action that might lead to its implementation.
RC: He (Mr. Tomlinson) starts his analysis with the proposition that when you make a deposit in a bank you no longer own it, the bank does, citing two English legal decision of the 19th century, which he would like to see reversed. I cannot argue the legal position, but as a practical matter a depositor always has the right to withdraw his demand deposit at will and his time deposit at maturity: is this not ownership? What upsets Mr. Tomlinson is that prior to your withdrawal, the bank can combine your money with other deposits and use the pooled funds to make loans over which you have no say-so whatever – in that sense, yes, you have lost control of your money. Of course, that has been the rock-bottom principle of banking from day one.
JB: Logically, before fractional reserve banking was started by one bank, banks practiced 100% reserve banking. The primeval principle, originating in natural law principles and codified by the Romans, later adopted by most western countries is that deposited things, including money, are not owned by the depository, but remain the property of the depositor.
The principle is based on the basic law regarding private property that one thing can not be wholly owned by more than one person at the same time. Under fractional reserve banking this principle is violated and under common law it would be fraud. The depository institution can not own it and show it as his asset and a liability in his accounting books. Deposits should be off balance sheet. The treatment of the so called “time deposits” which in reality are term loans by the clients of the bank to the bank should be different. Banks can do their business without fractional reserve banking and financing their loans portfolio with time deposits, bonds and similar fixed interest liabilities and equity. Fractional reserve banking is not an inherent characteristic of banking. It was the courts, by allowing the practice of fractional reserve banking, that perverted the working of these crucially important institutions (the banks).
RC:. He wants it abolished, on the theory that (1) only you should decide how your money is used, (2) the leverage of using your deposit allows banks to make loans that are inflationary and thus damaging to the economy, and (3) loans financed by deposits inevitably make the deposits risky.
JB: Mr. Tomlinson is right in that fractional reserve banking should be abolished because it is fraudulent violation of the deposit contract. It allows the bank to create title to property out of thin air (no additional property was created in the process) and puts the deposited money at risk in the process. He is also right when he says that such inflation, by reducing a key price in the economy, interest rates, causes the inflationary boom which leads to its inevitable consequence: the recession to cure the misallocation of resources provoked by the inflationary boom phase. To add insult to injury this process also generates a regressive redistribution of wealth from fixed income earners and savers and investors to banks and their debtor clients. Mr. Coulson needs to ask himself why it is that government courts broke the principle and still allow banks to continue to do this. Could it be that the mutually beneficial relationship between banks and governments have allowed banks to get away with it?
RC:. He wants it abolished, on the theory that (1) only you should decide how your money is used, (2) the leverage of using your deposit allows banks to make loans that are inflationary and thus damaging to the economy, and (3) loans financed by deposits inevitably make the deposits risky.
JB: I do agree with Mr. Coulson though in that time deposits (term loans to the bank by the depositor) do not need to be abolished to eliminate the inflationary creation of credit out of thin air by banks. Time deposits are wholly owned by one person only. The bank owns the money during the period of the time deposit and at maturity it is owned once again by the depositor. The loans made by the bank financed by time deposits and similar liabilities of the bank are not inflationary.
In such a bank, 100% reserve demand deposits and loans and other investments financed by time deposits, bonds and similar liabilities and equity, there is no need for deposit insurance as the main liquidity risk of banks has been eliminated by 100% reserves on demand deposits. In fact deposit insurance would be detrimental by leading to increased risk taking by banks.
Demand depositors will have to pay for the service and if they are willing to lend money in time deposits, bonds or otherwise will need to obtain reports on the quality of the banks’ portfolios and decide whether the rates offered compensate for the banks’ risk. This kind of banking does not require a central bank as a lender of last resort or issuer of currency.
Ideally, this banking system would be based in a currency which can not be manipulated by government, commodity money: gold or silver.
Finally, I would like to thank both Mr. John Tomlinson and Mr. Richard Coulson for their contributions to this most important discussion.
