"The Money Masters" & Positive Money

"Alarmist and naive, but a useful stimulus to thought"

"The Money Masters" is a 3.5 hour long documentary film made in 1996, narrated and largely written by William Still. It can be viewed online. It is alarmist and naive, but a useful stimulus to thought It exudes an aura of paranoid conspiracy theory, arguing that the money masters of the title, by the trick of 'fractional reserve banking', have won for themselves an unshakable grip on the entire power structure of the USA, from the banks and the money supply to the press; a power so great that Congress simply eats out of their hands. It is well researched and highly informative; I tend not to doubt the purely factual material it presents, but I do question the interpretation, the slant, the innuendo, the guesswork.

Major targets of the argument are: 'fractional reserve banking', our debt-based money-supply, and the business cycle (which is seen as a cynical device of the bankers to strip assets off the indebted). It is argued that the bankers' practice of lending out 10 (or 30) times as much money as is deposited with them allows them to charge interest on money that does not exist, except as debt. Their profit is seen as 10 (or 30) times as big as it should be. Admittedly, you and I could also operate this system, so interest rates should be fairly competitive. And people deposit money with banks as well as borrow from them, so it is the difference between borrowing and lending rates that provides the bank's profit. But there may be a point here to which I shall return.

The argument that Still has with a debt-based money supply is that if the banks wish to call in their debts (which they can do when these fall due for repayment) the economy finds itself in a recession simply because there is not enough cash in the system. By why would they do that if lending is where they get their profit? If they are really devious (it is argued), they might want to beggar some clients into forfeiting their collateral — so called 'predatory lending'. The 'Colonial Scrip' system of pre-revolutionary USA is held up as superior and quasi-ideal; a paper money system where 'fiat' money issued by the government can be used to pay for all goods and services in the absence of gold. A foolish government could (of course) issue too much 'Scrip', which would cause inflation, just as too little would cause deflation. Before the revolutionary war, Benjamin Franklin believed the amount of 'Colonial Scrip' was appropriate to the population. Or the needs of the population, for, as the population got wealthier, and bought carriages as well as bread, there would need to be more Scrip in circulation. William Still believes that this superior system was anathema to the Bank of England, and that the Bank had enough power in England to ban the printing of Colonial Scrip in the colonies.

However, it seems more likely it was the British merchants who did not want to be paid in a devaluing paper currency. The Currency Act of 1764 banning Scrip certainly produced tight money, economic depression, and enormous indignation; a major cause of the revolution. There seems no reason why our present government should not snap its fingers at the banking lobby and issue 'government scrip', if it wants; except that governments fear inflation. That is almost exactly the position we are in today. The Government wants banks to lend, so they give them cash; but the banks still do not lend, because we (the public) do not want to borrow. So our Government is teetering on the brink of issuing 'helicopter money' to all citizens so they can start buying things and re-launching industry. The hitch (presumably) is a doubt as to what would be purchased — our produce, or that of foreigners. There seems today to be a general consensus that the present system, whereby the money supply adjusts itself, is preferable to the Scrip system. Cash is added to the system in the weeks before Christmas and withdrawn again in February.

Alexander Hamilton (the force behind the creation of  America's first central bank of 1791, modeled on the Bank of England) is seen (by Still) as a "tool of the international bankers" (e.g. Rothschild); which seems hardly fair. I do not know why President Andrew Jackson was determined to abolish the second US central bank, perhaps because it operated an inflexible money supply, but bank-president Biddle reacted most unwisely. He seems deliberately to have induced a national depression by withdrawing money in an attempt to coerce President Jackson. The furious nation supported Jackson, and the bank was abolished. The United States had no central bank between 1836 and 1913. The present 'Fed' is a cumbersome, complex, subtle and typically American device, incorporating the sort of checks and balances (e.g. between private and state, banker and politician) seen in other US institutions. It seems to work well for the most part, and shows an ability to change in response to financial and political demands. Fed profits are paid to the Government.

Positive Money is a British pressure group that has worked very hard over the last 3 years to bring us to an understanding of how the evils of fractional-reserve banking and debt-based money supply have contributed to the financial instability of the last 5 years. Does that sound familiar? Its thrust seems like an updated British version of the same general argument as "The Money Masters". Once again I am sincerely grateful for the research, well-meaning effort, and clarity with which Positive Money has stimulated my own thinking (See Blog). Together with Richard Werner and The New Economics Foundation, Positive Money has made a submission to the Independent Commission on Banking, advocating not just a ring-fence but a complete separation into two types of bank; type [a] with full-reserve banking, no interest, but fees, and used for paying and receiving money; type [b] for receiving deposits and making loans.

Whatever the merits of the Positive Money submission, I do not see it getting anywhere as it is too radical; it will not appeal to the bankers, and the politicians will not sufficiently understand its merits. But what are its merits? At present, most of us keep only enough money in a 'current account' to defray expenses till the next income cheque. We are happy to rely on the Government guarantee that we shall not loose our money in the event of a bank crash. There seems to me no pressure to move to an [a]-type bank except to deny the bankers the privilege of using our money while it is in their hands. We enjoy 'free banking' because the banks make sufficient profit from lending out our money. By contrast, we would have to pay for the [a]-type bank. If the [b]-type bank deposits were not underwritten by the Government's £80,000 guarantee there would still be much grief in the event of bank failure, and the Government would probably have to step in after all. So no change. Banks would still lend happily against the collateral of a house, so favouring non-productive loans, as at present. So, I doubt there will be much serious discussion of the Positive Money submission.

I see one issue to be 'fractional reserve banking', and a second to be 'asymmetric risk'. The pressure on bankers to over-lend is what brought about the recent sub-prime mortgage debacle. So we must reduce the temptation to make risky loans. And increase the penalties for bad loans. There seems to me to be no reason why banks should keep the interest when they lend money they do not own. So my first simple suggestion is that the tax rate on profits from lending should be related to the capitalization of the bank. When a bank lends 10 times its capital, 90% of the interest it receives should be taxed away, leaving it only 10%. If it lends twice its capital, it retains half the profit. Simple!

It may be objected that when a bank lends out money, albeit money that it does not own, it runs the risk of not getting it back, and the interest is the compensation for that risk. That argument fails if the banks are bailed out by the state.

Banks operate to match loans to clients. If a loan defaults, the bank must certainly loose its share of the loan (10% or 50% in the above examples), but maybe should bear a stiffer penalty. The 19^th century mechanism was to let the over-extended banks fail, and then to lock up the board of directors for debt. That worked well enough to inculcate 4 generations of prudent banking and 130 years without a serious bank run; but the hardship to thousands of innocent depositors is now regarded as intolerable, and governments tend (it seems) to step in to supply the missing money. Fine, but I see no reason why the insolvent/imprudent bankers should escape, as they seem to be doing. Have any gone to prison? Has anyone drawn up a list of directors who would now be bankrupt were it not for the state's intervention? Or a balance sheet of the money that must be repaid to the public by the banking sector, bank by bank? This failure is not only unjust, the risk-asymmetry is very dangerous. Gambling for the bank is (currently) a case of "heads I win, tails you lose". An idiotic situation. The money must be recovered, however long that takes.

So my second simple suggestion is like the first: "tax or fine the banks".

L. Cawstein
cawstein@gmail.com