A Challenge to Banking
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SECTION ONE - Dishonest Money
The Hourglass Is Emptying
Is Western society running out of time? Can we afford to
ignore the warnings? One economic crisis seems to follow another;
each downturn seems to plunge the Western world into a deeper
recession. We have had the Third World debt crisis, the collapse
of the US savings and loan associations, two UK property crises,
the Japanese stock market has collapsed, the international
exchange value of both the dollar and the pound have fallen
dramatically, the ERM is under immense strain, German re-unification
is undermining the strength of the Deutschmark, and we have
had three major economic downturns - culminating in the recession
of the early 1990's, the worst since the depression of the
1930's. All of these have occurred since President Nixon closed
the "gold window" in 1971.
There can be little doubt that the imprudence of the banking
community has played a major role in each. These crises may
now be signalling to us that the international banking system
has already expanded the world's money supply to its point
of imprudence. With no international lender of last resort,
collapse of the world monetary system must be a strong possibility.
Indeed, the establishment of the Bank for International Settlements
as a "World Central Bank" has already been mooted.
Yet the establishment of an international Central Bank can
only temporarily avoid the eventual collapse of our existing
paper money system. It could bail out existing central banks
which have difficulties. They could in turn bail out existing
commercial banks which have been imprudent. But, we've seen
all of this before. That's how Central Banks came into existence
in the first place.
In the early days of banking, when depositors began to worry
about the security of their deposits in a particular private
commercial bank and all arrived simultaneously to withdraw
them, because the bank had built its business on the back
of misrepresentation there was not sufficient money available
to repay every depositor. Either some depositors would lose
all of their deposits or all depositors would lose some of
This, in turn, would raise questions in the minds of depositors
in other private commercial banks and would often pose a threat
to the survival of all banks and their deposits. It was under
these circumstances, where the interests of both banker and
depositor coincided, that Central Banks were born. Under pressure
from both depositor and banker alike, governments established
Central Banks as lenders of last resort. The newly created
Central Bank could then provide funds to meet withdrawals
where commercial bankers could not otherwise meet them. Thus,
the existence of Central Banks ensured the continuity of both
the customers' deposits and the commercial banks.
Herein lies the problem. By providing a safety net to bankers
whose misrepresentation had reached its point of imprudence,
Central Banks allowed the misrepresentation to continue and
gave it legitimacy. What we now face is the result of allowing
this behaviour to continue: imprudence on a massive scale
by governments, Central Banks themselves and the commercial
banking system as a whole.
The establishment of a "World Central Bank" can
only prolong the agony. It will license the continued imprudence
of governments, central banks, and commercial banks. Each
will then be free to continue its habitual misrepresentation
until a new point of imprudence is reached. Following that,
there can be no higher level upon which to create a lender
of last resort. There will be no further way of underpinning
the world's monetary system. Eventually any system based on
misrepresentation must collapse.
Individual governments are pursuing a relentless path of economic
expansion, without heed to the consequences. From their perspective,
it appears that the only way out of a contraction is to create
an expansion: to change the negative ripples for positive
ones. But the changes required to create an expansion weaken
In the course of a contraction, those borrowers who can survive
the decreased volume of exchanges and still set aside sufficient
units of money to repay their debts will do so. Their repayments
will help to strengthen the position of the surviving banks.
When the banks have received sufficient units of money through
repayments and new deposits, they may feel confident once
again to begin to expand their lending activities. But many
borrowers who have proven their worthiness by repaying their
loans will have no need to borrow to expand existing productive
capacity. Excess productive capacity will still exist in most
industries. Thus the bankers' natural drive for expansion
will be frustrated.
To continue to expand its lending business, the banking community
has historically had to look beyond its list of previously
acceptable borrowers. Criteria were adjusted so that the borrowing
market could be expanded to embrace a larger proportion of
the population. This has required a lowering of standards
of credit worthiness, weakening the assets against which depositors'
money has been secured. Emphasis has shifted from the financing
of productive capacity to the financing of consumption. These
changes in criteria have allowed the banking system to increase
its overall lending. Increased lending means increased interest
earned: means increased profitability: means increased inflation.
Yet it is this propensity which leads to a repetition of both
business and economic cycles. As lending is expanded, the
number of ripples which provide benefits will increase, and,
in due course, a general expansion of the economy will once
again begin. The difference between a business and an economic
cycle merely relates to the extent of the market-place affected.
At the root of both is the money lending activity of the banking
Each general expansion has been followed by a general contraction.
The duration of each general contraction has been determined
by the length of time required for the banking system to re-build
its reserves through the receipt of debt repayments. When
their reserves have become sufficiently strong for them once
again to begin seriously to expand their lending activities,
historically they have often had to look to a wider market
of acceptable borrowers. Even here the hourglass is emptying:
there is little room for expansion.
Initially the privilege of borrowing was restricted to the
wealthy, to those individuals who possessed assets whose value
far exceeded the amount borrowed or who possessed sufficient
power to command the money with which to repay a loan. Property
owners, merchants, industrialists, kings, princes and governments
could borrow. Today it is not even necessary to have assets.
Tomorrow's pay - unearned units of money of unknown future
value - is now acceptable as collateral. Thus the borrowing
market has been expanded from yesterday's rich and powerful
to embrace today the most humble of society's working men
Certainly in the Western industrial countries it is difficult
to envisage an expansion of the borrowing market so as to
embrace more individuals. But where is the market beyond the
West? It is unlikely that the wage levels in non-industrial
nations would allow their wage earners sufficient borrowing
capacity to fuel a significant expansion of the lending activities
of the Western banking system. Over the course of history,
long-term contracts have kept the real prices paid to many
less developed countries for raw materials at a low level.
Witness the combined effects of long-term contracts and inflation
on the purchasing power received per barrel of oil by the
National Iranian Oil Company. It was not until the major oil
producers in the world united to form a cartel that they held
sufficient power to raise the price of oil and redress their
losses. Few other producers of the raw materials required
to fuel the manufacturing processes and standard of living
of the Western industrial nations have been able to unite
to form such cartels.
During this same period, wage and price levels in the industrialised
countries have increased substantially. So, too, has the cost
of finance and the cost of plant and equipment. The net result
is that, in the West, raw materials now often represent an
unrealistically small portion of the cost of production.
In addition, many of the principal producers of these natural
resources, whether they are mines producing ores or large
farms producing foodstuffs, are also the principal employer
in their local economy. This leaves them in the position to
maintain downward pressure on the level of wages that they
pay to the local work force. In one province of the Dominican
Republic, for instance, there is one principal bauxite mine
and little else to provide employment. There is thus little
competition for local employment to provide a balancing upward
pressure. The same can be said of many of the mines in Africa
and of much of the sugar-cane production in the Caribbean
or Central America.
Wage earners of less developed countries have, therefore,
not been able to command a high level of wages and earnings
are substantially lower than in the industrial West. Expanding
the borrowing market to include the working people of the
less developed countries cannot produce a consumer-led boom
of any consequence in the industrialised nations.
On the other hand, an expansion of the borrowing market in
these countries can lead to economic growth in their own markets.
This is what is happening in the Pacific basin. Korea, Taiwan,
Singapore and Malaysia have booming economies. China is following
closely. Industries in these economies will compete with the
industries of the West. They have their own expanding banking
systems. In time they, too, will be unable to expand further.
Very real limits to the progressive march of expanding and
contracting cycles do exist. These cycles can only continue
until all existing borrowers and potential borrowers have
borrowed to their maximum, thereby saturating the borrowing
capacity of the entire world population. After that there
can be no major expansion of the borrowing market. Any expansion
which could follow would have to be a result of repayment
of existing debt or expansion of world population. Neither
can occur at a rate sufficient to fuel a new expansionary
It could also happen that, before the borrowing market becomes
totally saturated, total world productive capacity might so
exceed that required to satisfy world demand that no one would
seriously contemplate the construction of any new productive
capacity. Without the construction of new productive capacity
there will also be no major expansionary wave.
Yet expansion of the money supply is required to produce the
new units of money necessary to meet withdrawals and maintain
customer confidence. Without continuing expansion the banking
system cannot survive. Without new lending the current banking
system cannot expand. Without change the future of the Western
monetary and banking system looks very bleak indeed.
SECTION TWO - Honest Money
Corrective proposals flow with impeccable
logic from the analysis in Section 1, including a massive
world-wide conversion of debt to equity.
The Requirements of
Before undertaking any change, it is vital that we
have a clear picture of the requirements of sound money
and a sound monetary system. Here we set out the goal
that any change required must achieve.
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