Not many central bankers or regulators are willing or able to think deeply about the nature of money and the implications of the collapse of trust in banking. Two exceptions are Mervyn King and Peter Praet. This post is about them and other thinkers worth attending to.
King’s views are well known and he has done more than anybody else to put bank restructuring on the agenda in the UK. The endless flow of scandals have given his views a fair wind. In the UK, the first report of the Parliamentary Commission on Banking Standards and the continuing work of the Commission shows that some politicians are determined to hold the government’s feet to the fire.
Peter Praet is a deep thinker whose appointment as chief economist of the ECB is much to be welcomed. Peter understands the fragility of fiat money and fractional reserve banking systems:
“…reputation and trust in the ability of individual banks and the banking system as a whole to redeem the bills, the IOUs or the deposits is essential in order for the new fractional reserve system to function. Trust is the critical word. It becomes an intimate attribute of money.”
But Peter has to answer the question: what to do if, despite his efforts, that trust is lacking, not just for a few days or weeks, but for a prolonged period… or permanently?
That would happen if the public come to believe that creators of money, notably the banks, are using their power to loot from the public. And that public agencies are doing nothing effective to stop them.
That seems to be where we have been for the past five years. Yet very few insiders face up to it, or ponder its implications.
I predict that we will move, over time, to a new model of financial intermediation. Central banks must prod governments to encourage that transformaion and if necessary force it through. That must mean much more than just “electrifying the rung fence”.
Variable-value money market funds indicate one way forward – Goldman Sachs is paving the way by releasing daily valuation of some MMFs with no promise not to break the buck. Kotlikoff’s mutual fund banking is a more elaborate version. These and other options are analysed in Chapters 10, 14 and 15.
In any case the social value of banking – as it has come to be practised in the past generation – has been exaggerated. Adair Turner has done well to publicise this. Banks as we have known them are not indispensable. Indeed, if their net social contribution is negative, society would be better off without them.
Why hasn’t there been real reform? Barry Eichengreen hits the nail on the head when he concludes that the episode has not been bad enough to produce sufficient political will to change the system; that’s what distinguishes the feeble response this time to the radical reforms of the 1930s:
“Ultimately, the explanation for the passage of far-reaching financial reform can only be the severity of the crisis. In the 1930’s, the Great Depression brought the entire economy to its knees. The need for root-and-branch reform was undeniable. After 2008, by contrast, policymakers succeeded in preventing the worst, which ruled out the sense of urgency that surrounded the Pecora Commission hearings. “
“The ultimate irony is that this very success led to less reform.”
So it seems we are condemned to go through the charade yet another time. The same applies to monetary policy, and to reform of the international monetary system.
William White, now at the OECD, has reached similar conclusions with respect to the entire package of official macro economic and prudential measures.
“….the crisis was unexpected and shocking. However, far from questioning previous beliefs, a common response of “shocked” policymakers actually seems to have been a retreat back into the previous belief system. In effect, the response to the crisis has been “more of the same” policies that led to the crisis in the first place.
Bill cites a number of examples drawn from a variety of countries. What we need is a complete change in economists’ belief systems:
“In terms of process, the transition from one belief system to another is still incomplete. We are still at the stage of “cognitive dissonance” where old beliefs are being challenged by the facts. If it takes a further worsening of the crisis to finally effect the “paradigm shift”, then we are on an exceedingly dangerous path.”
The problem is that the same set of insiders are still in charge; and as Daniel Kahneman has shown, insiders can never lead change.
Towards a benign “New normal”
We need to apply concepts of fairness, justice, and equity to finance. We need to give all citizens a real stake in the financial system – and that can only be done if they have a shared ownership. The best course would be to make money itself a claim on real assets. That is the thought behind the Ikon.
A proper global financial system, one that would enable us to live with a globalised financial system and economy, would embrace a new model of banking as well as a monetary standard providing a common benchmark for monetary policies. That would also facilitate coordination of national policies. Governments would need to stick to it through initial storms. Then private sector agents will stabilise expectations round the new norms.
Governments are making big mistakes when they beg companies to invest, households to spend and banks to lend. It is wrong and undignified. It hands society to the bankers, big companies and the global elite. Instead, the public sector should build a robust framework of global rules and leave the private sector to adjust to those rules. One day, this will happen.
The world economy would then enter a dark tunnel. Adjustment would take time. The difference from today is that there would be light at the end of it.
Is real reform within our grasp?
Yes if we learn from people with something relevant to say
Not many central bankers or regulators are willing or able to think deeply about the nature of money and the implications of the collapse of trust in banking. Two exceptions are Mervyn King and Peter Praet. This post is about them and other thinkers worth attending to.
King’s views are well known and he has done more than anybody else to put bank restructuring on the agenda in the UK. The endless flow of scandals have given his views a fair wind. In the UK, the first report of the Parliamentary Commission on Banking Standards and the continuing work of the Commission shows that some politicians are determined to hold the government’s feet to the fire.
Peter Praet is a deep thinker whose appointment as chief economist of the ECB is much to be welcomed. Peter understands the fragility of fiat money and fractional reserve banking systems:
“…reputation and trust in the ability of individual banks and the banking system as a whole to redeem the bills, the IOUs or the deposits is essential in order for the new fractional reserve system to function. Trust is the critical word. It becomes an intimate attribute of money.”
But Peter has to answer the question: what to do if, despite his efforts, that trust is lacking, not just for a few days or weeks, but for a prolonged period… or permanently?
That would happen if the public come to believe that creators of money, notably the banks, are using their power to loot from the public. And that public agencies are doing nothing effective to stop them.
That seems to be where we have been for the past five years. Yet very few insiders face up to it, or ponder its implications.
I predict that we will move, over time, to a new model of financial intermediation. Central banks must prod governments to encourage that transformaion and if necessary force it through. That must mean much more than just “electrifying the rung fence”.
Variable-value money market funds indicate one way forward – Goldman Sachs is paving the way by releasing daily valuation of some MMFs with no promise not to break the buck. Kotlikoff’s mutual fund banking is a more elaborate version. These and other options are analysed in Chapters 10, 14 and 15.
In any case the social value of banking – as it has come to be practised in the past generation – has been exaggerated. Adair Turner has done well to publicise this. Banks as we have known them are not indispensable. Indeed, if their net social contribution is negative, society would be better off without them.
Why hasn’t there been real reform? Barry Eichengreen hits the nail on the head when he concludes that the episode has not been bad enough to produce sufficient political will to change the system; that’s what distinguishes the feeble response this time to the radical reforms of the 1930s:
“Ultimately, the explanation for the passage of far-reaching financial reform can only be the severity of the crisis. In the 1930’s, the Great Depression brought the entire economy to its knees. The need for root-and-branch reform was undeniable. After 2008, by contrast, policymakers succeeded in preventing the worst, which ruled out the sense of urgency that surrounded the Pecora Commission hearings. “
“The ultimate irony is that this very success led to less reform.”
So it seems we are condemned to go through the charade yet another time. The same applies to monetary policy, and to reform of the international monetary system.
William White, now at the OECD, has reached similar conclusions with respect to the entire package of official macro economic and prudential measures.
“….the crisis was unexpected and shocking. However, far from questioning previous beliefs, a common response of “shocked” policymakers actually seems to have been a retreat back into the previous belief system. In effect, the response to the crisis has been “more of the same” policies that led to the crisis in the first place.
Bill cites a number of examples drawn from a variety of countries. What we need is a complete change in economists’ belief systems:
“In terms of process, the transition from one belief system to another is still incomplete. We are still at the stage of “cognitive dissonance” where old beliefs are being challenged by the facts. If it takes a further worsening of the crisis to finally effect the “paradigm shift”, then we are on an exceedingly dangerous path.”
The problem is that the same set of insiders are still in charge; and as Daniel Kahneman has shown, insiders can never lead change.
Towards a benign “New normal”
We need to apply concepts of fairness, justice, and equity to finance. We need to give all citizens a real stake in the financial system – and that can only be done if they have a shared ownership. The best course would be to make money itself a claim on real assets. That is the thought behind the Ikon.
A proper global financial system, one that would enable us to live with a globalised financial system and economy, would embrace a new model of banking as well as a monetary standard providing a common benchmark for monetary policies. That would also facilitate coordination of national policies. Governments would need to stick to it through initial storms. Then private sector agents will stabilise expectations round the new norms.
Governments are making big mistakes when they beg companies to invest, households to spend and banks to lend. It is wrong and undignified. It hands society to the bankers, big companies and the global elite. Instead, the public sector should build a robust framework of global rules and leave the private sector to adjust to those rules. One day, this will happen.
The world economy would then enter a dark tunnel. Adjustment would take time. The difference from today is that there would be light at the end of it.
Written on January 20, 2013 at 3:37 pm, by robert
Categories: Banking, Homepage, News and Comment, RP's Diary | Tags: Bank of England, banking, Barry Eichengreen, Bill White, central banking, ECB, Eichengreen, financial crisis, G20, global financial system, International Monetary System, Kahneman, Mervyn King, OECD, Praet, White, William White