Читать книгу NoNonsense The Money Crisis - Peter Stalker - Страница 11
Оглавление2 The creation of banks
People with money or other valuables looked for ways of keeping these safe, by storing them in the vaults of goldsmiths or pawnbrokers. But then something strange happened. These canny operatives started to multiply the contents of their vaults. And nowadays their heirs, the commercial banks, similarly create money out of thin air, or out of flows of electrons. Governments have tried to manage this financial fecundity through their central banks but have never fully succeeded.
Having pondered on the origins of cash and coinage, it is now time to take a closer look at banks. Banking too has an ancient history regularly punctuated with sorry tales of greed and disaster. The money-changers in Rome were some of the earliest practitioners. Mostly, however, they did not lend money but just changed some of the gold or silver coins of foreign traders into the denarii that could be used when operating in Rome. Indeed the word ‘bank’ derives from the benches, called ‘bancu’, from which these and other proto-bankers plied their trade. You will not be surprised that they soon also needed a term for a bank failure – ‘bankrupt’ – which corresponds to someone taking a sledgehammer to the aforementioned bench to signal the demise of the enterprise.
Banks lend money, charging varying prices for their services through rates of ‘interest’. This word derives from medieval Latin, from ‘inter’ meaning ‘between’, and ‘esse’ to ‘be’. The lender was said to ‘have an interest’ in the transactions for which their money had been borrowed, and interest subsequently came to refer to the level of compensation they charged for being deprived of the funds while someone else used them. The more devoutly religious considered this process abhorrent since it involved monetizing time – over which only the deity should have domain. They thus considered charging interest as an attempt to usurp divine power and condemned it as the sin of usury. It should be noted, however, that interest does not just involve considerations of time, but also takes into account the risk that the borrower might never repay.
Christians became more relaxed about the concept of interest from around the 11th century, not least because they wanted to borrow funds to finance wars against other religious groups – Muslims primarily, but also Jews or Orthodox Christians, or indeed anyone who rejected the authority of the Pope. This involved a series of crusades, the first of which aimed to retake Jerusalem from its Islamic occupants. From the 13th to the 15th centuries, these punitive expeditions were financed by wealthy enterprises in Venice and Genoa.
Pious though they may have been, these financiers required compensation, so they carefully devised ways of charging that made lending seem less sinful. Eventually the word usury became confined to lending at rates of interest that are excessive, though what constitutes excess is always a matter of judgment. Payday lenders are notorious for charging stratospheric rates of interest of 2,000 per cent or more – usury by any standard – but even people borrowing from Visa or MasterCard will face annual interest rates of 25 per cent or more. To this day, Islam forbids charging any interest, though Islamic scholars will advise financiers on how to get round this constraint, for a fee.
The making of modern banking
By the 17th century, elements of modern banking were starting to emerge. At that time one of the main centers of international trade was Amsterdam. The busy merchants of the city, who had money pouring in from all directions, soon found themselves dealing with a baffling array of coinage. The Dutch Republic alone had at least 14 mints that were turning out coins of all different sizes, shapes and qualities – which were then mingled with all the cash arriving from overseas. In 1606 the Dutch parliament issued a guide for the perplexed – a money-changer’s manual which listed no fewer than 341 silver and 505 gold coins.
This period amply demonstrated that ‘bad money drives out good’ – a principle articulated in 1558 by the financial agent of Queen Elizabeth I of England, Thomas Gresham, and known thereafter as Gresham’s Law. If, for example, you have what you consider an iffy dollar bill, you will be tempted to palm it off on someone else as soon as possible, while keeping in your wallet all the other bills you believe to be the genuine article. In the 16th century people had much the same attitude to coins, especially those which looked as though they might have had some of their gold clipped off. The clipped coins naturally circulated the fastest. One of the neatest anti-clipping measures was devised by the ever-busy Sir Isaac Newton who, in addition to explaining the laws of motion, and devising the infinitesimal calculus and so much more, also became warden of the Royal Mint in 1696 and suggested milling fine lines into the edges of coins so as to make any clipping more obvious.1
Dodgy coins
Coping with all this dubious coinage was at best inconvenient and at worst exposed the merchants and their customers to fraud. To cut through this financial clutter, in 1609 the City of Amsterdam established what we might now call a public bank. This cheerfully allowed people to deposit all their coins, but did so with due skepticism, evaluating their true worth by checking their weight and quality. After making a deduction for expenses, the bank would then note the true value of the coins and keep them in storage. The depositor could use these verified coins to make payments to another customer by asking the bank to shift them to that person’s storage box. The owners of the coins thus had simple ‘bank accounts’. This proved such a useful function that similar banks were established in other cities across Europe.
This also opened up opportunities for lending. If one Dutch merchant was short of cash, he or she could negotiate directly with another of the bank’s customers for a loan at an agreed rate of interest. The lender could thus instruct the bank to move the coins to the borrower’s storage box or, more likely, just to transfer ownership by changing a few numbers in their ledgers. Once the transfer had taken place, the lender started to earn interest, but also had to accept the risk that the borrower might default. The banks soon realized, however, that with so much unused cash in their vaults they too could use it to make loans, with or without the explicit consent of the depositors.
Something similar was happening with goldsmiths and pawnbrokers. In London in the 17th century, faced with multiple risks of plague, fire and war, many people would leave their gold coins and other valuables with various businesses for safekeeping – in particular those with strong vaults. To this day the official arbiter of British coinage is the Goldsmiths’ Company of the City of London.2 To recognize that they held these valuables, the goldsmiths would issue receipts or ‘notes’. If the depositor later wished to ‘spend’ their valuables for some purpose they could present the note and ask for them back. However, they might find it more convenient just to spend the notes. If the goldsmith was reputable, the receipt itself was ‘as good as gold’ and anyone holding it could go to the goldsmith and take the metal itself. This is thought to be the origin of the ‘promissory note’ – what we would now think of as a banknote.
Then some enterprising goldsmith took an important new step by handing notes not just to depositors but also to people who wanted to borrow money and were prepared to pay interest. These notes did not correspond to any particular deposit of gold but rather reflected the fact that there was a lot of gold in the vaults. Nevertheless, the goldsmiths still required a reassuring amount of gold and needed to attract more deposits. They thus started offering interest to the depositors.
You will have noticed a sleight of hand which, if not actually dishonest, is at best risky. If everyone awkwardly shows up with their notes simultaneously demanding the equivalent in gold or coins they might be disappointed. Once depositors suspect their funds may not be available for withdrawal, they are apt to bang on the doors, asking for their money back – and thus triggering a ‘run on the bank’. Regrettably, that was the ultimate fate of the Bank of Amsterdam. Having lent out too much to the Dutch East India Company and to the City of Amsterdam, it was forced to limit withdrawals and in 1819, after two decades of operation, had to be wound up.
Nevertheless, it had helped to establish a general model of banking that has survived largely intact. This is partly because it has proved useful for both borrowers and lenders. When Willie Sutton, a notorious bank robber in New York in the 1930s, was asked why he robbed banks, he famously replied: ‘Because that’s where the money is.’
To disguise the inherent risk, banks have done all they can to appear solid institutions. In the past, they tended to construct even their smallest branches to look as imposing as possible – sometimes with stout Greco-Roman porticos that looked as though they could withstand several earthquakes. And bank managers, until recently at least, also wore very sober suits, and were considered the epitome of respectability.
Even so, to this day, what banks do is essentially a conjuring trick. In fact they do not wait for anyone to make a deposit before making a loan. If they think that the borrower looks creditworthy they simply open a bank account and declare that the borrower has those funds in it. As the Canadian-born economist JK Galbraith memorably put it: ‘The process by which banks create money is so simple that the mind is repelled. Where something so important is involved a deeper mystery seems only decent.’
Is the loan really money? Yes it is. The borrower can write a cheque, or make a bank transfer, on this amount to buy goods. If this transaction is with another customer of the same bank then the funds are transferred from one to the other. If the check is paid into an account in another bank much the same situation applies, except that there has to be an exchange between banks. In practice the major banks have a huge number of mutual transactions every day, most of which cancel out. But what if they do not? Enter the central bank.
Central banks
Each country that issues its own currency has a central bank. In the US, for example, this is the Federal Reserve. In Australia it is the Reserve Bank of Australia. In Canada it is the Bank of Canada. There are also central banks for countries that share a currency; in the case of the euro, this is the European Central Bank. While you might assume that central banks are government operations, in fact many started out as private companies. The Reserve Bank of India, for example, was established in 1935 as a private company, though it was nationalized at independence in 1949.
The oldest of the central banks is the Bank of England which was founded in 1694 by a Scotsman, William Paterson. At that time the King of England, William III, also known as William of Orange, was in dire need of funds, not least because of his frequent quarrels with France. Paterson came up with a solution. He would create a new bank and sell shares in it. Then he could lend all the proceeds to the King, who could use these funds to fight the French. Paterson’s proposal went down well. The King awarded the Bank of England a Royal Charter and promptly borrowed all the capital – £1.2 million. Previously all banks had been privately owned. Paterson’s Bank of England, however, was to be a ‘joint stock’ company. This meant that it would not only raise its initial capital funds by selling shares but would also be a ‘limited’ company, so if it collapsed its owners would not have to pay debtors out of their own pockets – they had limited liability, in other words.
At the same time the Bank of England was a commercial operation that could take deposits and make loans. The fact that the King had already walked off with all the bank’s subscribed funds, and thus its capital, was not a problem since he had left an IOU. The King was a decent credit risk and was likely to repay eventually, if only by taxing his citizens. This meant that the shareholders got double value for their investment. First, the King was paying interest on the loans. Second, based on his £1.2 million the bank could lend out the same amount in banknotes – it could ‘monetize’ the debt for other profitable lending through the issue of Bank of England banknotes. King William was much impressed by this wizardry and wanted further loans, requiring the Bank to raise yet more capital by selling more shares. The Bank of England had thus issued the notes that formed the British money supply based on a royal debt. To this day the British Crown has not repaid this. Indeed, it has been argued that, if it did, the entire British monetary system would collapse.3
The new Bank of England maintained a reputation for sound management. It ensured that it always kept enough coins on hand so that anyone who presented one of its notes was promptly repaid in silver or gold coins. But since the bank had government backing, few people actually tried to redeem their notes. At that point other English banks were also still issuing notes, but these were considered less reliable and thus less acceptable for payment. Soon most of the notes in circulation were those of the Bank of England. Nevertheless, it did occasionally run into problems after it issued large numbers of notes and at one point was forced temporarily to suspend the right of bearers to redeem their notes for gold or silver. To correct this tendency to overlend, in 1844 a new Bank Charter established that the Bank could only print additional notes that corresponded to the gold and silver that it maintained in its vaults – akin to what would later be called the ‘gold standard’.
At that point, in most respects, the Bank of England remained just one commercial bank among many. In time, however, it started to take on what we now recognize to be the functions of a central bank. Not only did it have a quasi-monopoly on the right to issue paper money, it also became responsible for the control of other banks.
Nowadays, if any company wants to become a bank, they need a banking licence. This brings certain privileges but also a degree of regulation. The main privilege is that they can create deposits out of thin air and lend them to customers. Other institutions, such as savings and loan institutions, are allowed to make loans but these have to be with funds that have been saved with them. They are not allowed to create money. A banking licence thus sounds like a licence to print money, and in many respects it is.
But there are limitations. One is that every licensed bank is required to maintain a substantial sum at the central bank in the form of ‘central bank reserves’. Another is a requirement for the bank to hold enough ‘liquid assets’ to meet potential withdrawals – which could be central bank reserves or government bonds or cash. Originally in the UK this was fixed as a set percentage or ‘fraction’ of all its outstanding loans. Should the percentage drop below this critical level, it would need topping up, by offering the central bank government bonds, for example, or by borrowing from the central bank at the prevailing interest rates. This system is known as ‘fractional reserve banking’. The UK subsequently dropped this reserve ratio and instead now tries to achieve the same thing by requiring important banks to pass a ‘stress test’, to check that they can withstand a crisis. Other countries, including the US, still maintain such a ratio, also called a liquidity ratio, of around 10 per cent. Canada and Australia, like the UK, do not.
This also addresses the issue of how to resolve payments between banks. If one bank owes a net amount to another, this can ultimately be settled by making transfers between their reserve accounts at the central bank.
Pulling the monetary levers
In countries such as India, where the state owns many of the banks that lend funds to the general public, it is easy enough for the government both to dictate to banks and to control the money supply. In most developed countries, however, the banks have largely been independent commercial enterprises so the central bank has to exert control indirectly. Although the terminology differs from country to country, the means are more or less common.
The first lever of control is through interest rates. Interest rates can be thought of as the charge for renting out money. If you were renting someone a car you would take into account many factors. What is the risk that the renter might drive off into the sunset and never return? What could I otherwise have done with the car during that time? Will the engine wear out during that period? What are other people charging for that kind of car?
Renting out money involves similar considerations. You have to assess the risk that the borrower might default or disappear. You have to consider the rate of inflation, and thus the likelihood that when you get your money back it will be worth less. And of course you have to check what your competitor banks are offering since they might undercut your rates.
Within these constraints, banks can charge whatever they like. But they are also influenced by what the central bank declares to be the ‘minimum lending rate’ – in the US the ‘discount rate’. This is the rate at which the central bank will lend to the commercial banks. They may, for example, need to borrow from the central bank if they have to boost their central bank reserves, or they need a reliable source of ready cash should they be faced with a sudden bout of withdrawals. The commercial banks can smooth out some of these daily fluctuations by borrowing from each other, but they also have the option of borrowing from the central bank. Commercial banks making loans to their customers will generally use the central bank rate as a starting point, while adding a percentage point or two to cover their expenses, the likelihood of default, and the desired profits.
Interest rates
When it comes to setting interest rates, governments have several things to worry about. The first is inflation. The Bank of England, for example, is charged by the British government with the responsibility of keeping inflation below 2 per cent. If the Bank sees inflation creeping up, it may therefore decide to increase interest rates. Higher interest rates will discourage borrowing, or encourage people to repay existing loans, which can reduce the money supply and economic activity and thus help dampen inflation. If the central bank raises the rate at which it lends to commercial banks, this puts pressure on the banks to pass on the costs to their customers by raising the interest rates they themselves are charging.
The other main consideration when setting interest rates is employment. Stifling economic activity may have the merit of reducing inflation. This is fine if most working people have jobs. But there is always the risk of overdoing it, of slowing the economy down so much that there is a rise in unemployment. So governments have to strike a balance. Interest rates too low: inflation. Interest rates too high: unemployment.
This may give the impression that it is possible to fine-tune the economy to achieve the optimum balance. If only. In practice, economies respond to changes in interest rates, if at all, in the same way the proverbial oil tanker responds to a tweak to the tiller. The response time can be very long, up to a year; indeed, so long that, by the time any interest-rate changes take effect, the circumstances might have changed so dramatically that the central bankers would have been better steering in the opposite direction. And even if the general course was correct, there is always the risk of undershooting or overshooting. In the UK, the decisions are made by a group of wise persons, the Monetary Policy Committee, which generally changes rates quite slowly, typically by one quarter of one percentage point in either direction. Because these changes are so small, they are generally quoted in smaller units. One percentage point can also be referred to as 100 ‘basis points’ – so in this case the change would be only 25 basis points.
This interest-rate tinkering appeared to work until the financial crisis. After this the situation became so dire that governments desperate to revive their ailing economies slashed interest rates so that they were close to zero – where they have remained ever since. This particular lever thus got stuck and could do little more to stimulate the economy. In fact, banks were reluctant to lend money at any interest rate because of fears that the borrowers would go bust.
The Libor scandal
Banks are not forced to take loans from the central bank. They can instead borrow ready cash from elsewhere, including from each other in what is called the ‘interbank’ market. Ultimately, the rate at which they do so will be set by market forces – by the amount of spare cash the banks have at the time. The actual rate in London, for example, is called the London Interbank Offered Rate – Libor – which is also used as a reference point for banks elsewhere and for credit-card companies. Until recently, Libor was based on a fairly casual reporting system on the assumption that the bankers would simply tell the truth. This was a mistake. In 2008, it was revealed that for many years bankers had often chosen to lie, saying that they could borrow more cheaply than they actually could, so that they would appear to be in a healthier position than they really were – which is fraud. In 2013, the Royal Bank of Scotland, for example, acknowledged that, between 2006 and 2010, 21 traders and one manager had tried to rig Libor. To settle US and UK investigations, it agreed to pay fines of $612 million.4
Lending between banks, honest or not, might seem to cut the central bank out of the picture. But not entirely. The central bank itself also intervenes through what are called ‘open-market operations’. If it wants to reduce the amount of cash in the banking system it has the option not only of increasing the base rate but also of hoovering up some cash by offering to sell government bonds at attractive rates. As will be explained later, a bond is a promise to pay whoever buys it a certain sum of money each year and to return the whole sum after a pre-determined period. Once these government bonds have been sold, they can then be traded on the open market. If, on the other hand, the central bank wants to stimulate economic activity because it is worried about rising unemployment and wants to increase the money supply, it does the reverse. It goes back to the bond market offering to pay whatever it takes to buy back such bonds, thus injecting more cash into the system.
On occasion, however, banks may be so chronically short of money, and nervous that fellow banks might go bust overnight, that they refuse to lend to them at any interest rate. This was the situation following the credit crunch from 2008. Banks hit by losses stemming, among other things, from mortgage defaults in the US, were so spooked that they clung onto the cash they had, so that interbank credit largely dried up. In these circumstances, the central bank can deploy another of its weapons, by acting as a ‘lender of last resort’. If a commercial bank is basically solvent – in that it has sufficient deposits and capital, but just does not have enough funds readily available to pay immediate needs – the central bank can lend it funds and avoid an unnecessary collapse.
Solvents and liquids
At this stage it is worth mulling over what ‘solvent’ means. If you have simple financial affairs and have $20,000 in the bank and total outstanding bills of only $10,000, then you are solvent. On the other hand, if you only have $10,000 but owe $20,000 you are in a less happy position. As an individual, you may not worry about this, on the grounds that you have a job which keeps enough money flowing in to pay the interest on the loans. But technically, if you have no other assets, you are insolvent. This is more of a problem for companies, including banks, which legally are not allowed to continue trading while insolvent. If you are insolvent, then creditors may take you to court to have you declared legally bankrupt.
But being insolvent is not the same as being ‘illiquid’. You might think that being illiquid – which sounds equivalent to solid – is a good thing. But for a bank it can be a problem. Return to the situation where you were declared technically insolvent, but then you suddenly remembered that you owned a house worth $100,000. Immediately you realize that you are solvent. Phew! However, because most of your assets are tied up in bricks and mortar and you don’t have much ready cash, you are considered illiquid. In the long term you should be OK but in the short term you may need to borrow some money to pay your immediate bills, perhaps using your house as security.
Banks too can be solvent but illiquid. They might, for example, lend someone the cash to buy a house and not expect to see all the money back for 20 years. This loan represents an asset for the bank but not one it can use immediately, so if it were faced with a lot of withdrawals it could face a liquidity crisis. While it is still probably solvent, since the loans it made still count as assets, it has nevertheless become illiquid.
The lender of last resort
In this case it may well need to borrow from the central bank – the lender of last resort. The Bank of England took on this responsibility from around 1825. Recognizing the value of having a central bank for these and other purposes, many other countries followed suit. The Banque de France emerged from 1800 and in 1875 the Bank of Prussia became the Reichsbank. The US equivalent, the Federal Reserve System (the ‘Fed’), was created in 1913 following a series of financial panics. The Fed is not just one institution but a system, which includes a central governmental agency in Washington DC, a Board of Governors, and 12 regional Federal Reserve Banks, which perform central banking functions within their own regions. The most important of these is the Federal Reserve Bank of New York which, as well as regulating New York banks, is responsible for the Fed’s open-market operations.
Having a ‘lender of last resort’ offers a degree of security. The downside is ‘moral hazard’ – a situation where people protected from the consequences of their actions are tempted to take greater risks. Bankers, knowing that they have a central bank safety net, may make dangerous bets in search of higher profits and personal bonuses. Even if the bets fail, the bank is likely to survive. Governments will step in because bank failures are dangerous. Politicians fear the fallout from angry small depositors, but also know that the banks are intricately interconnected through webs of interbank lending so that the failure of one bank to repay an overnight loan could topple many other dominoes.
Another concern is that the central banks themselves might be subject to political manipulation. A government approaching an election may, for example, be tempted to reduce interest rates and expand the money supply to make people feel suddenly richer, even though soon after the election this could cause inflation. To guard against this ‘boom and bust’ strategy, most central banks in developed countries operate with a degree of independence. This can be achieved partly through long-term directorships. Although the directors or governors of central banks are political appointees, their terms of office will generally extend beyond the life of most governments. In the US, for example, the seven board members of the Fed are appointed for a term of 14 years, with one member’s term expiring every other year. Nevertheless, the independence of central banks has limits. In practice most governments at times of economic crisis lean on central banks to take politically expedient decisions.
The Bank of England was nationalized in 1947 and essentially acted as a part of the government. But from 1997 it was granted operational independence, which meant that it was given the overall task of managing interest rates and the money supply. As noted earlier, it has been charged with keeping inflation at around two per cent – but is free to adjust interest rates as it sees fit in order to achieve this. The European Central Bank, which is in charge of monetary policy in those countries using the euro, has a similar target, as does the Bank of Canada. For the Reserve Bank of Australia the target is two to three per cent and for the Reserve Bank of New Zealand it is one to three per cent. In the US the Fed has two targets. The first is concerned with keeping down inflation, the other with maintaining high levels of employment. This is a trickier task since the two targets often conflict.
Policing the banks
