Time to Reform Our Banks?

A brother in law of mine started out his career as a bookkeeper by taking a job with what looked like an upcoming construction firm. Up to then it had been keeping its own books, but with growth, it seemed sensible for management to take the next step of hiring a professional to keep its accounts.

It did not take very long for my relative to find a rather substantial error in the books. An important item had been entered as a credit when in fact it was a debit. The firm was not prospering, but in fact close to collapse. So instead of starting out on a promising career, his employment for the next year was to work for the bankruptcy trustee, winding up the whole operation for the benefit of unpaid creditors.

As I look out over the world’s economic prospects for 2009, and the desperate moves by governments worldwide to borrow billions of dollars created by the banking system from that same system in order to provide funds to prevent it from collapse, I get a sense that something is equally wrong here in the way the books are being kept.

For many years, I have carried in my wallet a quotation from the late professor Frederick Soddy, Nobel Prizewinner in 1922 for his work on the chemistry of radioactive substances, who coined the word ‘isotope’, and visualized in the midst of World War I the possible use of atomic power either as an instrument of war or as an enormous contribution to the world’s peace and plenty. Concerned by the fact that economies became incredibly productive under the pressure of war, but found themselves unable to deal with unemployment and poverty in time of peace, he attempted to understand the economic system. He says:

“I thought that, as a scientific man, I ought to know something about economics. So I studied the money system for two years and could make nothing of it. Then one day the truth dawned on me. What I was studying was not a system, but a confidence trick.”

The essential element in this trick is the technique of banking. Before goldsmiths became bankers, a deposit of gold with them would incur a charge for storage. As with a safety deposit box, one would leave the metal with the goldsmith, and expect to pay for the safekeeping, and receive the precisely same unit of gold back when withdrawn. Hence the term ‘deposit’.

In the sixteen hundreds, however, there was a new development. Samuel Pepys, for instance, records in his diary at that time how delighted he was when he found that, instead of paying for storage of his wealth, he could be actually be paid for leaving money ‘on deposit’ with a banker. The difference? First of all, the gold he received back would not be the same gold that he deposited. Secondly, the gold he had deposited would be lent out to some third party, with interest paid to the bank, and lesser amounts then credited to Pepys. Thirdly, that what stood to Pepys’s credit until he withdrew his ‘deposit’ was not gold, but a promise to pay that could be transferred by cheque and in many cases treated as money. Fourthly—and very relevant in today’s world—that if people lost confidence in their bank, or too many people sought to withdraw their money when it had already been loaned elsewhere, the bank would fail and its promises to repay would be worthless, leading to the ruination of all concerned. Fifthly, the effect of the same money being considered to be in more than one place at once was to expand the quantity of money in the economy, so causing inflation of prices by diluting the value of each individual monetary unit. The ‘South Seas Bubble’ of the early seventeen hundreds was only the first of many inflationary bubbles brought about by this system. Banker and borrower alike made a profit until the bubble burst—this at the expense of the general public, whose savings bought less.

All these things are only too evident in today’s economy. Inflation is persistent, and has reduced the value of the dollar and so of savings to one tenth of the value they had fifty years ago. Debts grow out of control. Obscene rewards have gone to those knowing how to make use of this substitute money system, which enables the money creators to print the tickets and grow rich, while the rest of the world slaves to do the work and provide the products those tickets will buy. And the reserves of cash needed for this system to operate have been allowed to become so thin that major bank failures have begun to happen, and the supply of credit for industry has dried up.

The flaw in the accounting system? Gold may be an asset of real value, but a bank’s promise to pay is not an asset but a liability of the bank, supported by the liability of the borrower to repay the credit the bank has extended to him. A system that has negative feedback is self-correcting and stable, but this new arrangement has created a situation of positive feedback, where inflation leads to more inflation, and deflation leads to unemployment, poverty and economic collapse. No amount of juggling with interest rates can prevent this from happening.

Banks by their very nature cannot create credit without creating an equal amount of debt—hence the enormous and growing personal and national debts that cost us so much in taxation, cripple our ability to enjoy products that are waiting for us to buy them, and lead to ever more consumer debt, longer mortgages on ever more costly housing, rent increases, foreclosures and homelessness. It’s not that everyone in the financial industry is a criminal—finance is essential to our modern civilization. What is essential is that we recognize that the rules by which we operate the system at present are impractical and unsustainable, and lead to wasteful and oppressive consequences that could easily be avoided.

If our politicians would ‘think outside the box’, they would realize that it is possible to create dollars without creating debt—but not through the banking system. The Mint does it with coinage all the time. Abraham Lincoln in the United States did it by issuing ‘Greenback’ dollars. England at the start of World War I abandoned gold sovereigns as money, and printed and circulated Treasury notes. The Bank of Venice financed Italy’s most successful trading city in this way for six hundred years. Alberta itself worked on the same principle by setting up the Treasury Branch system, operating at one time “on a one per cent reserve and a hot line to the United States”. It was a factor that helped Alberta get out of the poverty of the depression years, and still gives this Province an economic advantage.

The time has come for public and politicians to start thinking ‘outside the box’ as we face the coming economic catastrophe. It’s nothing but an accounting problem. The world could be as productive as it was twelve months ago, if only we would reform the rules of the financial system to make this possible.

Will we? Who knows.

– Publication Unknown, 2009*
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