Part 1 appeared in the November–December 2014 issue of ER.
Source: http://bit.ly/1rqvLxQ
Steve Baker:
…My bottom line on this is: I want to live in a society where even the most selfish person is compelled by our institutions to serve the needs of other people. The institution in question is called a free market economy, because in a free market economy people do not get any bail-outs and do not get to live at somebody else’s expense; they have to produce what other people want. One thing that has gone wrong is that those on the right have ended up defending institutions that are fundamentally statist.
Douglas Carswell (Clacton) (UKIP):
I congratulate the hon. Gentleman on bringing this important subject to the attention of the House. Does he agree that, far from shoring up free market capitalism, the candy floss credit system the state is presiding over replaces it with a system of crony corporatism that gives capitalism a bad name and undermines its very foundations?
Steve Baker:
I am delighted to agree with my hon. Friend – he is that, despite the fact I will not be seeing Nigel later. We have ended up pretending that the banking system and the financial system is a free market when the truth is that it is the most hideous corporatist mess. What I want is a free market banking system, and I will come on to discuss that.
I wanted to make some remarks about price signals, but I will foreshorten them, and try to cover the issue as briskly as I can – it was the subject of my maiden speech. Interest rates are a price signal like any other. They should be telling markets about people’s preferences for goods now compared with goods later. If they are deliberately manipulated, they will tell entrepreneurs the wrong thing and will therefore corrupt people’s investment decisions. The bond and equity markets are there to allocate capital. If interest rates are manipulated and if new money is thrown into the system, prices get detached from the real world values they are supposed to be connected to – what resources are available, what technology is available, what people prefer. The problem is that these prices, which have been detached from reality, continue to guide entrepreneurs and investors, but if they are now guiding entrepreneurs and investors in a direction that takes them away from the real desires of the public and the available resources and the technology, we should not then be surprised if we end up with a later disaster.
In short, after prices have been bid up by a credit expansion, they are bound to fall when later the real world catches up with it. That is why economies are now suffering this wrecking ball of inflation followed by deflation, and here is the rub: throughout most of my life, the monetary policy authorities have responded to these corrections by pumping in more new money – previously through ever cheaper credit, and now through QE. This raises the question of where this all goes, and brings me back to the point my hon. Friend the Member for Stone (Sir William Cash) provoked from me: that this might be pointing towards an end of this monetary order. That is not necessarily something to be feared, because the monetary order changed several times in the 20th century.
We have ended up in something of a mess. The Governor said about the transition once interest rates normalise:
“The orderliness of that transition is an open question.”
I believe the Governor is demonstrating the optimism appropriate to his role, because I think it is extremely unlikely that we will have an orderly transition once interest rates start to normalise. The problem is basically that Governments want to spend too much money. That has always been the case throughout history. Governments used to want to fund wars. Now, for all good, moral, decent, humanitarian reasons, we want to fund health, welfare and education well beyond what the public will pay in taxes. That has meant we needed easy money to support the borrowing.
What is to be done? A range of remedies are being proposed. Positive Money proposes the complete nationalisation of the production of money, some want variations on a return to gold, perhaps with free banking, and some want a spontaneous emergence of alternative moneys like Bitcoin.
I would just point out that Walter Bagehot is often prayed in aid of central banking policy, but his book Lombard Street shows that he did not support central banking; he thought it was useless to try to propose any change. What we see today is that, with alternative currencies such as Bitcoin spontaneously emerging, it is now possible through technology that, within a generation, we will not all be putting our money in a few big mega-banks, held as liabilities, issued out of nothing.
I want to propose three things the Government can practically do. First, the present trajectory of reform should be continued with. After 15 years of studying these matters, and now having made it to the Treasury Committee, I am ever more convinced that there is no way to change the present monetary order until the ideas behind it have been tested to destruction – and I do mean tested to destruction. This is an extremely serious issue. It will not change until it becomes apparent that the ideas behind the system are untenable.
Secondly, and very much with that in mind, we should strongly welcome proposals from the Bank’s chief economist, Andy Haldane, that it will commission “antiorthodox research,” and it will “put into the public domain research and analysis which as often challenges as supports the prevailing policy orthodoxy on certain key issues.”
That research could make possible fundamental monetary reform in the event of another major calamity.
Thirdly, we should welcome the Chancellor’s recent interest in crypto-currencies and his commitment to make Britain a “centre of financial innovation.” Imperfect and possibly doomed as it may be, Bitcoin shows us that peer-to-peer, non-state money is practical and effective. I have used it to buy an accessory for a camera; it is a perfectly ordinary legal product and it was easier to use than a credit card and it showed me the price in pounds or any other currency I liked. It is becoming possible for people to move away from state money.
Every obstacle to the creation of alternative currencies within ordinary commercial law should be removed. We should expand the range of commodities and instruments related to those commodities that are treated like money, such as gold. That should include exempting VAT and capital gains tax and it should be possible to pay tax on those new moneys. We must not fall into the same trap as the United States of obstructing innovation. In the case of the Liberty Dollar and Bernard von NotHaus, it seems that a man may spend the rest of his life in prison simply for committing the supposed crime of creating reliable money.
Finally, we are in the midst of an unprecedented global experiment in monetary policy and debt. It is likely, as Philip Coggan set out, that this will result in a new global monetary order. Whether it will be for good or ill, I do not know, but as technology and debt advance, I am sure that we should be ready for a transformation. Society has suffered too much already under the present monetary orthodoxy; free enterprise should now be allowed to change it.
Mr Michael Meacher (Oldham West and Royton) (Lab):
I, too, strongly congratulate the hon. Member for Wycombe (Steve Baker) on securing this debate, which everyone recognises is vital and which has not been debated in this House for 170 years, since Sir Robert Peel’s Bank Charter Act 1844. The hon. Gentleman drew that fact to my attention when we were last speaking in a similar debate. That Act prohibited the private banks from printing paper money. In light of the financial crash of 2008-09 and the colossal expansion of money supply that underpinned it – no less than a twenty-two-fold increase in the 30 neo-liberal years between 1980 and 2010 – the issue is whether that prohibition should be extended to include electronic money.
It is unfortunate that it is so little understood by the public that money is created by the banks every time they make a loan. In effect, the banks have a virtual monopoly – about 97% – over domestic credit creation, so they determine how money is allocated across the economy. That has led to the vast majority of money being channelled into property markets and the financial sector. According to Bank of England figures for the decade to 2007, 31% of additional money created by bank lending went to mortgage lending, 20% to commercial property, and 32% to the financial sector, including to mergers and acquisitions and trading and financial markets. Those are extraordinary figures.
Mr Jim Cunningham (Coventry South) (Lab):
Given what my right hon. Friend has just said, is there not an argument, in this situation of unlimited credit from banks, for the Bank of England to intervene?
Mr Meacher:
My hon. Friend anticipates the main line of my argument, so if he is patient I think I will be able to satisfy him. Crucially, only 8% of the money referred to went to businesses outside the financial sector, with a further 8% funding credit cards and personal loans.
Mr MacNeil:
I hear what the right hon. Gentleman says about money going into building, housing and mortgages, but is that not because the holders of money reckon that they can get a decent return from that sector? They would invest elsewhere if they thought that they could get a better return. One reason why the UK gets a better return from that area than, say, Germany is that we have no rent controls. As a result, money is more likely to go into property than into developing industry, which is more likely to happen in Germany.
Mr Meacher:
I very much agree with that argument. Again, I assure the hon. Gentleman that I will return to that matter later in my speech. He is absolutely right that the reason is the greater returns that the banks can get from the housing and rental sector. Our rental sector, which is different from that in Germany and other countries, is the cause of that.
It is only this last 16% – the 8% lent to businesses and the 8% to consumer credit – that has a real impact on GDP and economic growth. The conclusion is unavoidable: we cannot continue with a system in which so little of the money created by banks is used for the purposes of economic growth and value creation and in which, instead, to pick up on the point made by the hon. Member for Na h-Eileanan an Iar (Mr MacNeil), the overwhelming majority of the money created inflates property prices, pushing up the cost of living.
In a nutshell, the banks have too much power and they have greatly abused it. First, they have been granted enormous privileges since they can create wealth simply by writing an accounting entry on a register. They decide who uses that wealth and for what purpose and they have used their power of credit creation hugely to favour property and consumption lending over business investment because the returns are higher and more secure. Thus the banks maximise their own interests but not the national interest. Secondly, if they fail to meet their liabilities, the banks are not penalised. Someone else pays up for them. The first £85,000 of deposits are covered by a guarantee underwritten by the state and in the event of a major financial crash they are bailed out by the implicit taxpayer guarantee
Steve Baker
rose
Mr Meacher:
Let me finish, and I will of course give way.
The banks have been encouraged by that provision into much more risky, even reckless, investment, especially in the case of exotic financial derivatives
Mr Jim Cunningham
rose
Mr Meacher:
Members are beginning to queue up to intervene, but let me finish my point first. The banks have been encouraged even to the point at which after the financial crash of 2008-09 the state was obliged to undertake the direct bail-out costs of nearly £70 billion as well as to provide a mere £1 trillion in support of loan guarantees, liquidity schemes and asset protection arrangements.
Steve Baker:
I wholly agree with the right hon. Gentleman. The moral hazard problem is absolutely enormous and one of the most fundamental problems. However, the British Bankers Association picked me up when I said it was a state-funded deposit insurance scheme and told me it was industry-funded. I think the issue now is that nobody really believes for a moment that the scheme will not be back-stopped by the taxpayer.
Mr Meacher:
As always, I am grateful for the intervention from the hon. Gentleman – let me call him my hon. Friend, as I think that on this issue he probably is.
Mr Jim Cunningham:
On the question of banks investing in the property market, does my right hon. Friend think we could learn anything from the United States and the collapse of Fannie Mae? Are we in a similar situation?
Mr Meacher:
Again, that takes me down a different path, but there is considerable read-across.
Douglas Carswell:
The right hon. Gentleman has been absolutely magnificent in diagnosing the problem, but when it comes to the solution and passing power away from banks, rather than passing the power upwards to a regulator or to the state, would he entertain the idea of empowering the consumer who deposits money with the bank? Surely the real failure is that the Bank Charter Act 1844 does not give legal ownership of deposits to the person paying money into the bank. The basis of fractional-reserve banking is the legal ownership the bank has when money is paid in. If we tackle that, the power will pass from the big state-subsidised corporations and banks outwards to the wider economy.
Mr Meacher:
I have great sympathy with what the hon. Gentleman is saying
Ms Diane Abbott (Hackney North and Stoke Newington) (Lab)
rose
Mr Meacher:
One at a time, please. I was going to say a little bit more than that I had sympathy with what the hon. Member for Clacton (Douglas Carswell) said.
I will argue that the capacity to regulate an increasingly and exceedingly complex financial sector is not the proper way, and I will propose an alternative solution. I am strongly in favour of structural changes that enable people to achieve greater control over the money that they have contributed.
Ms Abbott:
I was intrigued to hear my right hon. Friend mention depositor protection. Is he saying that he is against any form of depositor protection?
Mr Meacher:
The protection of deposits is up to £85,000 and is underwritten by the state.
Ms Abbott: Is my right hon. Friend against?
Mr Meacher: I am neither for nor against. I am making the point that the arrangement encourages the banks to increase their risk taking. If they are caught out, for each depositor £85,000 is guaranteed by the state. I agree with the hon. Member for Wycombe that we need much wider structural change. It is not a question of tweaking one thing here or there.
The question at the heart of the debate is who should create the money? Would Parliament ever have voted to delegate power to create money to those same banks that caused the horrendous financial crisis that the world is still suffering? I think the answer is unambiguously no. The question that needs to be put is how we should achieve the switch from unbridled consumerism to a framework of productive investment capable of generating a successful and sustainable manufacturing and industrial base that can securely underpin UK living standards.
Two models have hitherto been used to operate such a system. One was the centralised direction of finance, which was used extremely successfully by several Asian countries, especially the south-east Asian so-called tiger economies, after the second world war, to achieve take-off. I am not suggesting that that method is appropriate for us today. It is not suited to advanced industrial democracies. The other method was to bring about through official “guidance” the rationing of bank credit in accordance with national targets and, where necessary, through quantitative direct controls. In the post-war period, that policy worked well in the UK for a quarter of a century, until the 1970s when it was steadily replaced by the purely market system of competition and credit control based exclusively on interest rates. In our experience of the past 30 or 40 years, that has proved deeply unstable, dysfunctional and profoundly costly.
Since then there have been sporadic attempts to create a safer banking system, but these have been deeply flawed. Regulation under the dictates of the neo-liberal ideology has been so light-touch – by new Labour just as much as by the other Government – that it has been entirely ineffective. Regulation has been too detailed. I remind the House that Basel III has more than 400 pages, and the US Dodd-Frank Bill has a staggering 8,000 pages or more. It is impossibly bureaucratic and almost certainly full of loopholes. Other regulation has been so cautious – for example, the Vickers commission proposal for Chinese walls between the investment and retail arms of a bank – that it missed the main point. Whatever regulatory safeguards the authorities put in place faced regulatory arbitrage from the phalanx of lawyers and accountants in the City earning their ill-gotten bonuses by unpicking or circumventing them.
Mr Ronnie Campbell (Blyth Valley) (Lab):
My right hon. Friend is always very good on these subjects. Would I be going too far if I were to suggest that we should nationalise the City, nationalise the banks and run ourselves a Government on behalf of the people?
Mr Meacher:
Public ownership of the banks is a significant issue, but I am not going to propose it in my speech. It would be a mistake to return RBS and Lloyds to the private sector, and the arguments about Barclays and HSBC need to be made, but not in this debate. I shall suggest an alternative solution that removes the power of money creation from the banks and puts it in different hands to ensure better results in the national interest.
Against that background, there are solid grounds for examining – this is where I come to my proposal – the creation of a sovereign monetary system, as recommended by several expert commentators recently. Martin Wolf, who, as everyone in this House will know, is an influential chief economics commentator for the Financial Times, wrote an article a few months ago – on 24 April, to be precise – entitled, “Strip private banks of their power to create money.” He recommends switching from bank-created debt to a nationalised money supply.
Lord Adair Turner, the former chair of the Financial Services Authority, delivered a speech about 18 months ago, in February 2013, discussing an alternative to quantitative easing that he termed “overt money finance,” which is also known as a from of sovereign money. Such a system – I will describe its main outline – would restrict the power to create all money to the state via the central bank. Changes to the rules governing how banks operate would still permit them to make loans, but would make it impossible for them to create new money in the process. The central bank would continue to follow the remit set by the Chancellor of the Exchequer, which is currently to deliver price stability, which is defined at the present time as an inflation target of 2%. The central bank would be exclusively responsible for creating as much new money as was necessary to support non-inflationary growth. Decisions on money creation would be taken independently of Government by a newly formed money creation committee or by the existing Monetary Policy Committee, either of which would be accountable to the Treasury Committee. Accountability to the House is crucial to the whole process.
Mr Jim Cunningham:
Going back to the question I asked my right hon. Friend earlier, what would be the role of the Bank of England?
Mr Meacher:
I will come on to explain that. The Bank of England has an absolutely crucial role to play. If my hon. Friend listens to the last bit of my speech, he will get a full answer to that question.
A sovereign money system thus offers – if I may say this – a clear thermostat to balance the economy, which is notoriously lacking at present. In times when the economy is in recession or growth is slow, the money creation committee would be able to increase the rate of money creation, to boost aggregate demand. If growth is very high and inflationary pressures are increasing, it could slow down the rate of money creation. That would be a crucial improvement over the current system, whereby the banks either produce too much mortgage credit in a boom because of the high profit prospects, which produces a housing bubble and raises house prices, or produce too little credit in a recession, which exacerbates the lack of demand.
Lending to businesses is central to this whole debate.
Derek Twigg (Halton) (Lab):
I want to take my right hon. Friend back to when he mentioned accountability to Parliament and the Select Committee. Could he enlarge on that point? On accountability, what powers would Parliament have to ensure that his proposal was being followed through properly and the rules were being laid down?
Mr Meacher:
The purpose of accountability to the Treasury Committee would be to enable Parliament fully to explore the manner in which the money creation committee or the Monetary Policy Committee was working. I would anticipate a full three-hour discussion with the leading officials of those committees before the Treasury Committee, and if necessary they could be given a hard time. Certainly, the persons in this House who are most competent to deal with the matter would make clear their priorities, and where they thought the money creation committee was not paying sufficient attention to the way in which it was operating, and they would suggest changes. They would not have the power formally to compel the money creation committee to change, but I think the whole point about Select Committees, which are televised and discussed in the media, is that they have a very big effect. That would be a major change compared with what we have at present. Like all systems, if it is inadequate it can be modified, changed and increasingly enforced.
Sir William Cash:
With reference to the Treasury Committee, does the right hon. Gentleman see a potential role for some form of joint Committee, perhaps with the Public Accounts Committee, whose origins are to do with taxation and spending? Does he think that broadening scrutiny a little in that direction might be helpful so that we get the full benefit of the all-party agreement of both Committees?
Mr Meacher:
That is a helpful intervention. Although it is a relatively big part of what I am proposing, it is not for me to suggest exactly what the structure of accountability should be. I would be strongly in favour of increasing it as the hon. Gentleman proposes. Until this House is content that it has a proper channel of accountability which is effective in terms of the way our financial system is run, we should bring in further changes to the structure of accountability as may be necessary, such as along the lines that he suggests.
On lending to businesses, the experience that we have had in the past half-decade has been very unsatisfactory. Under a sovereign monetary system, the central bank would be empowered to create money for the express purpose of that funding role. The money would be lent to banks with the requirement that the funds were used for productive purposes, whereas lending for speculative purposes – for example, to purchase preexisting assets, either financial or property – would not be allowed. The central bank could also create and lend funds to other intermediaries – the hon. Member for Wycombe referred to this – such as regional or publicly owned business banks, which would ensure that a floor could be placed under the level of lending to businesses, which would be a great relief to British business, guaranteeing support for the real economy.
To avoid misunderstanding, I should add that within the limits imposed by the central bank on the broad purposes for which money may be lent, lending decisions would be entirely at the discretion of the lending institutions, not of the Government or the central bank.
I believe that a sovereign monetary system offers very considerable advantages over the current system. First, it would create a better and safer banking system because banks would have an incentive to take lower levels of risk, as there would be no option of a bail-out or rescue from taxpayers and thus moral hazard would be reduced. Secondly, it would increase economic stability because money creation by banks tends to be procyclical, as I explained, whereas money creation by the central bank would be countercyclical. Thirdly, sovereign money crucially supports the real economy, whereas under the current system 83% of lending does not at present go into productive investment. I underline that three times.
Ann McKechin:
My right hon. Friend said that the aim would be to reduce risk and for banks to be more cautious, but if we are to encourage innovation in manufacturing, would we not require an investment bank at state level that could fund the riskier levels of innovation to ensure that they get to market, because they are not at the point where they would be commercially viable?
Mr Meacher:
That is an extremely important point and, again, I strongly support it. The current Secretary of State for Business, Innovation and Skills has been struggling to introduce a Government-supported business investment bank and has recently announced something along those lines. I think that should be greatly expanded. The book by Mariana Mazzucato, which I hope most of us have read, The Entrepreneurial State, shows the degree to which funding for major innovation, not just in this country but in many other countries which she cites, has been financed through the state because the private sector was not willing to take on board the risk involved. One understands that, but one does need to recognise that the role of the state is extremely important, and under a Labour Government I would like to see something like this being brought in.
Ian Murray (Edinburgh South) (Lab):
My right hon. Friend makes a tremendous case for money creation and what we should be considering in this House, but I wonder whether there is also a cultural issue. Many businesses and lenders tell me that there is a cultural problem in the United Kingdom for businesses, particularly entrepreneurial businesses that we have heard about from my hon. Friend the Member for Glasgow North (Ann McKechin), with regard to giving away equity rather than creating debt – funding businesses through equity rather than debt. Other countries throughout Europe that are incredibly successful at giving away equity rather than creating debt have much more growth in their entrepreneurial economy.
Mr Meacher:
That is perfectly true, and my hon. Friend makes an important point. The proposals that I am making would support that. There is a very different climate in this country, largely brought about by the churning in the City of London where profits have to be increased or reach a relevant size within a very short period, such as three or six months. Most entrepreneurial businesses cannot possibly produce a decent profit within that period, so the current financial system does not encourage what my hon. Friend wants. These proposals would make money creation available to those we really want to support much more fully than at present.
Fourthly, under the current system, house price bubbles transfer wealth, as we all know, from the young to the old and from those who cannot get on the property ladder to existing house owners, which increases wealth inequality, while removing the ability of banks to create money should dampen house price rises and thus reduce the rate of wealth inequality.
My fifth and last point, which I think is very important, is that sovereign money redresses a major democratic deficit. Under the current system, around just 80 board members across the largest five banks make decisions that shape the entire UK economy, even though these individuals have no obligation or mandate to consider the needs of society or the economy as a whole, and are not accountable in any way to the public: it is for the maximisation of their own interests, not the national interest. Under sovereign money, the money creation committee would be highly transparent – we have discussed this already – and accountable to Parliament.
For all those reasons, the examination of the merits of a sovereign monetary system is now urgently needed, and I call on the Government to set up a commission on money and credit, with particular reference to the potential benefits of sovereign money, which offers a way out of the continuing and worsening financial crises that have blighted this country and the whole international economy for decades.
12.13 pm
Mr Peter Lilley (Hitchin and Harpenden) (Con):
It is a pleasure, as always, to follow the right hon. Member for Oldham West and Royton (Mr Meacher), who gave us a characteristically thoughtful and radical speech. I do not necessarily start from the same premises as him, but what he says is an important contribution to the debate, on the securing of which I credit my hon. Friend the Member for Wycombe (Steve Baker). He has done the House and the country a service by forcing us to focus on the issue of where money comes from and what banks do. He did so in an insightful way. Above all, he showed that he sees, as our old universities used to see, economics as a branch of moral sciences. It is not just a narrow, analytical, economic issue, but a moral, philosophical and ultimately a theological issue, which he illuminated well for the House.
A lot has been made of the ignorance of Members of Parliament of how money is created. I suspect that that ignorance, not just in Members of Parliament but in the intellectual elite in this country, explains many things, not least why we entered the financial crisis with a regulatory system that was so unprepared for a banking crisis. I suspect that it is because people have not reflected on why banks are so different from all other capitalist companies. They are different in three crucial respects, which is why they need a very different regulatory system from normal companies.
First, all bankers – not just rogue bankers but even the best, the most honourable and the most honest – do things that would land the rest of us in jail. Near my house in France is a large grain silo. After the harvest, farmers deposit grain in it. The silo gives them a certificate for every tonne of grain that they deposit. They can withdraw that amount of grain whenever they want by presenting that certificate. If the silo owner issued more certificates than there was grain kept in his silo, he would go to jail, but that is effectively what bankers do. They keep as reserves only a fraction of the money deposited with them, which is why we call the system the fractional reserve banking system. Murray Rothbard, a much neglected Austrian economist in this country, said very flatly that banking is therefore fraud: fractional reserve banking is fraud; it should be outlawed; banks should be required to keep 100% reserves against the money they lend out. I reject that conclusion, because there is a value in what banks do in transforming short-term savings into long-term investments. That is socially valuable and that is the function banks serve.
We should recognise the second distinctive feature of banks that arises directly from the fact that they have only a fraction of the reserves against the loans they make: banks, individually and collectively, are intrinsically unstable. They are unstable because they borrow short and lend long. I have been constantly amazed throughout the financial crisis to hear intelligent people say that the problem with Northern Rock, RBS or HBOS, or with the German, French, Greek and other banks that ran into problems, was the result of their borrowing short and lending long, and they should not have been doing it, as if it was a deviation from their normal role. Of course banks borrow short and lend long. That is what banks do. That is what they are there for. If they had not done that they would not be banks. Banking works so long as too many depositors do not try to withdraw their funds simultaneously. However, if depositors, retail or wholesale, withdraw or refuse to renew their shortterm deposits, a bank will fail.
If normal companies fail, there is no need for the Government to intervene. Their assets will be redeployed in a more profitable use or taken over by a bettermanaged company. But if one bank fails, depositors are likely to withdraw deposits from other banks, about which there may also be doubts. A bank facing a run, whether or not initially justified, would be forced to call in loans or sell collateral, causing asset prices to fall, thereby undermining the solvency of other banks. So the failure of one bank may lead to the collapse of the whole banking system.
The third distinctive feature of banks was highlighted by my hon. Friend the Member for Wycombe: banks create money. The vast majority of money consists of bank deposits. If a bank lends a company £10 million, it does not need to go and borrow that money from a saver; it simply creates an extra £10 million by electronically crediting the company’s bank account with that sum. It creates £10 million out of thin air. By contrast, when a bank loan is repaid, that extinguishes money; it disappears into thin air. The total money supply increases when banks create new loans faster than old loans are repaid. That is where growth in the money supply usually comes from, and it is the normal situation in a growing economy. Ideally, credit should expand so that the supply of money grows sufficiently rapidly to finance growth in economic activity. When a bank or banks collapse, they will call in loans, which will reduce the money supply, which in turn will cause a contraction of activity throughout the economy.
In that respect, banks are totally different from other companies – even companies that also lend things. If a car rental company collapses, it does not lead to a reduction in the number of cars available in the economy. Its stock of cars can be sold off to other rental companies or to individuals. Nor does the collapse of one rental company weaken the position of other car rental companies; on the contrary, they then face less competition, which should strengthen their margins.
The collapse of a car rental company has no systemic implications, whereas the collapse of a bank can pull down the whole banking system and plunge the economy into recession. That is why we need a special regulatory regime for banks and, above all, a lender of last resort to pump in money if there is a run on the banks or a credit crunch, yet this was barely discussed when the new regulatory structure of our financial and banking system was set up in 1998. The focus then was on consumer protection issues. Systemic stability and the lender-of-last-resort function were scarcely mentioned. That is why the UK was so unprepared when the credit crunch struck in 2007. Nor were these aspects properly considered when the euro was set up. As a result, a currency and a banking system were established without the new central bank being given the power to act as lender of last resort. It has had to usurp that power, more or less illegally, but that is its own problem.
This analysis is not one of those insights that come from hindsight. Some while ago, Michael Howard, now the noble Lord Howard, reminded Parliament – and indeed me; I had completely forgotten – that I was shadow Chancellor when the Bill that became the Bank of England Act 1998 was introduced. He pointed out that I then warned the House that
“With the removal of banking control to the Financial Services Authority…it is difficult to see how…the Bank remains, as it surely must, responsible for ensuring the liquidity of the banking system and preventing systemic collapse.”
And so it turned out. I added: “setting up the FSA may cause regulators to take their eye off the ball, while spivs and crooks have a field day.” – [Official Report, 11 November 1997; Vol. 300, c. 731-32.]
So that turned out, too. I could foresee that, because the problem was not deregulation, but the regulatory confusion and the proliferation of regulation introduced by the former Chancellor, which resulted from a failure to focus on the banking system’s inherent instability, and to provide for its stability.
This failure to focus on the fundamentals was not a peculiarly British thing. The EU made the same mistakes in spades when setting up the euro, and at the very apogee of the world financial system, they deluded themselves that instability was a thing of the past. In its “Global Financial Stability Report” of April 2006, less than 18 months before the crisis erupted, the International Monetary Fund, no less, said:
“There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped to make the banking and overall financial system more resilient…. The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently, the commercial banks…may be less vulnerable today to credit or economic shocks.”
The supreme irony is that those at the pinnacle of the world regulatory system believed that the very complex derivatives that contributed to the collapse of the financial system would render it immune to such instability. We need constantly to be aware that banks are unstable, and are the source of money. If instability leads to a crash, that leads to a contraction in the money supply, and that can exacerbate and intensify a recession.
Bob Stewart (Beckenham) (Con):
I am listening carefully to my right hon. Friend. Does that mean that the banks are uncontrollable, as things stand?
Mr Lilley:
No; they can and should be controlled. They are controlled both by being required to have assets, and ultimately by the measures that Government should take to ensure that they do not expand lending too rapidly. That is the point that I want to come on to, because a failure to focus on the nature of banking and money creation causes confusion about the causes of inflation and the role of quantitative easing.
As too many people do not understand where money comes from, there is confusion about quantitative easing. To some extent, the monetarists, of whom I am one, are responsible for that confusion. For most of our lifetime, the basic economic problem has been inflation. There have been great debates about its causes. Ultimately, those debates were won by the monetarists. They said, “Inflation is caused by too much money – by money growing more rapidly than output. If that happens, inevitably and inexorably, prices will rise.” The trouble was that all too often, monetarists used the shorthand phrase, “Inflation is caused by Government printing too much money.” In fact, it is caused not by Government printing the money, but by banks lending money and then creating new money at too great a rate for the needs of the economy. We should have said, “Inflation follows when Governments allow or encourage banks to create money too rapidly.” The inflationary problem was not who created the money, but the fact that too much money was created.
The banks are now not lending enough to create enough money to finance the growth and expansion of the economy that we need. That is why the central bank steps in with quantitative easing, which is often described as the bank printing money. Those who have been brought up to believe that printing money was what caused inflation think that quantitative easing must, by definition, cause inflation. It only causes inflation if there is too much of it – if we create too much money at a faster rate than the growth of output, and therefore drive up prices – but that is not the situation at present.
Mr MacNeil: The right hon. Gentleman is giving a very good explanation of the different circumstances in which money is created. He has spoken about the morality, and about quantitative easing. When there is demand, what is his view of the theory of helicopter money, and where that money gets spread to?
Mr Lilley:
As a disciple of Milton Friedman, I am rather attracted to the idea of helicopter money; I think it was he who introduced the metaphor, and said that it would be just as effective if money were sprayed by a helicopter as if it were created by banks. Hopefully, as I live quite near the helicopter route to Battersea, I would be a principal recipient. I do not think that there is a mechanism available that would allow us to do that, but I am not averse to that in principle, if someone could do it. My point is that the banks, either spontaneously or encouraged by the central bank through quantitative easing, must generate enough money to ensure that the economy can grow steadily and stably.
Mr MacNeil:
Could it not be argued that increasing welfare payments would be a form of helicopter money, because the people most likely to spend money are those with very little money? If we put money in the pockets of those who have little money, it would be very positive, because of the economic multiplier; the money would be spent, and would circulate, very quickly.
Mr Lilley:
There are far better reasons for giving money to poor people than because their money will circulate more rapidly – and there is no evidence for that; I invite the hon. Gentleman to read Milton Friedman’s A Theory of the Consumption Function, which showed that that is all nonsense. There are good reasons for giving money to poor people, namely that they are poor and need money. Whether the money should be injected by the Government spending more than they are raising, rather than by the central bank expanding its balance sheet, is a moot point.
All I want to argue today is that we should recognise that the economy is as much threatened by a shortage of money as it is by an excess of money. For most of our lifetimes the problem has been an excess, but now it is a shortage. We therefore need to balance in either occasion the rate of growth of money with the rate of growth of output if we are to have stability of prices and stable economic activity. I congratulate my hon. Friend the Member for Wycombe on bringing these important matters to the House’s attention.
12.30 pm
Austin Mitchell (Great Grimsby) (Lab):
I welcome this debate and congratulate hon. Friends on securing it, because we have not debated this matter for over 100 years, and it is time we did so. This House and the Government are obsessed with money and the economy, but we never debate the creation of money or credit, and we should, because, when it comes to our present economic situation and the way the banks and the economy are run, that is the elephant in the room. It is time to think not outside the box, but outside the banks; it is time to think about the creation of credit and money.
I speak as a renegade social creditor who is still influenced by social credit thinking; I do not pledge total allegiance to Major Douglas, but I am still influenced by him. As has just been pointed out, 93% of credit is created by the banks, and a characteristic of what has happened to the economy since the ’70s is the enormous expansion of that credit. I have here a graph from Positive Money showing that the money created by the banks was £109 billion in 1980. Thanks to the financial reforms and the huge increase in the power of the banks since then, by 2010 that figure had risen to £2,213 billion, whereas the total cash created by the Government – the other 3% – had barely increased at all. Since 2000 we have seen the amount of money created by the banks more than double.
That has transformed the economy, because it has financialised everything and made money far more important. It has created debt-fuelled growth followed by collapse. It is being controlled by the banks, which have directed the money into property and financial speculation. Only 8% of the credit created has been lent to new businesses. The Government talk about the march of the makers, but the makers are not marching into the banks, because the banks are turning them away. Even commercial property is more important than makers. That has created a very lop-sided economy, with a weak industrial base that cannot pay the nation’s way in the world because investment has been directed elsewhere, and a very unequal society, which has showered wealth on those at the top, as Piketty shows, and taken it away from those at the bottom.
A very undesirable situation is being created. We have built an unstable economy that is very exposed to risk and to bubble economics, thanks to the financialisation process that has gone on since 1979. The state allocates all credit creation to the banks and then has to bail them out and guarantee them, at enormous expense and with the creation of debt for the public, when the bubble bursts and they collapse.
Some argue – Major Douglas would have argued this – that credit should therefore be issued only by the state, through the Bank of England. That would probably be a step too far in the present situation, given our present lack of education, but we can and should create the credit issued by the banks. We can and should separate the banks’ utility function – servicing our needs, with cheque books, pay and so on – and their speculative role. The Americans have moved a step further, with the Volcker rule, but it is not quite strong enough. In this country we tend to rely on Chinese walls, which are not strong at all. I think that only a total separation of the banks’ utility and speculative arms will do it, because Chinese walls are infinitely penetrable and are regularly penetrated.
We can limit the credit creation by the banks by increasing the reserve ratios, which are comparatively low at the moment – the Government have been trying to edge them up, but not sufficiently – or we could limit their power to create credit to the amount of money deposited with the banks as a salutary control. We could tax them on the hidden benefit they get from creating credit, because they get the seigniorage on the credit they create. If credit is created by banknotes and cash issued by the Government, the Government get the profit on that – the signorage. The banks just take the signorage on all the credit they issue and stash it away as a kind of hidden benefit, so why not tax that and give some of the profit from printing money to the state?
Martin Wolf, in an interesting article cited by my right hon. Friend the Member for Oldham West and Royton (Mr Meacher), has argued that only central banks should create new money and that it should be regulated by a public credit authority, rather like the Monetary Policy Committee. I think that that would be a solution and a possible approach. Why should we not regulate the issue of credit in that fashion?
That brings us back to the old argument about monetarism: whether credit creation is exogenous or endogenous. The monetarists thought that it was exogenous, so all we have to do is cut the supply of money into the economy in order to bring inflation under control. That was a myth, of course, because we cannot actually control the supply of money; it is endogenous. The economy, like a plant, sucks in the money it needs. But that can be regulated by a public credit authority so that the supply matches the needs of the economy, rather than being excessive, as it has been over the past few years. I think that that kind of credit authority needs to be created to regulate the flow of credit.
That brings me to the Government’s economic policy. The Government tell us that they have a long-term economic plan, which of course is total nonsense. Their only long-term economic plan is slash and burn. The only long-term economic planning that has been done is by the Bank of England.
To be continued. The debate can be seen online at www.youtube.com/watch?v+EBSlSUITKM and read at http://bit.ly/1rqvLxQ.
