Ring fencing banks

Apparently “City leaders” are now “in secret talks with Treasury on weakening the ‘ring-fence’ scheme after fears global lenders will abandon Britain” (Sunday Times, 17th May).  This has been precipitated by the threatened departure from these shores of HSBC.  The only surprising thing about this news is that it has taken so long.

My blog on the topic in December 2012 concluded “It is truly astonishing that this [Vickers] Commission should choose to focus its entire attention on the area that matters least [ring-fencing the banks’ retail activities].  The consequence of adopting their suggestions, as Vickers himself seems to be pointing out, can only be that we will hobble our own financial sector at great cost to the economy and the British taxpayer.”

The Treasury has to this day claimed that the public were demanding ring-fencing but that is nonsense.  Hardly anyone understands what it involves.  Invite the general public to sign a ring-fencing petition and see how many sign up.  The only reason they might is because the big banks do not like it.  Those few denizens of the City and Westminster who do understand what it involves fall into two camps: fantasists and realists.

The fantasists believe that investment bankers brought down their retail siblings and that, in turn, created the 2008 crash.  Actually it was caused by the retail sector giving mortgages, largely under US government instruction, to poor people who could not pay their debts.  Much the same happened in the UK: remember those building societies which turned themselves into retail banks?  They went to the wall first.

The realists know that however the regulators write the rules, those working for the same global corporation will find ways of cooperating.  That is what global corporations do.  Chinese walls are not even paper thin.

One, rather more practical, option was completely to separate retail from wholesale as the US used to do. That was abandoned by the Vickers Commission for good reasons.

The new government has better things to do with its time and attention than fiddle around with this, starting with resolving a deal with the EU.  There is zero chance that the rest of the EU is going to ring-fence their banks.  The Treasury should announce that, to be consistent with other EU banks, the whole topic will be postponed until after the EU referendum.

No, let’s not try to abolish cash

There’s an idea being floated that we should abolish cash, move over entirely to electronic money, so as to be able to control boom and bust in the economy. There’s three reasons (at least) why we think this is a bad idea:

In this futuristic world, all payments are made by contactless card, mobile phone apps or other electronic means, while notes and coins are abolished. Your current account will no longer be held with a bank, but with the government or the central bank. Banks still exist, and still lend money, but they get their funds from the central bank, not from depositors.

Having everyone’s account at a single, central institution allows the authorities to either encourage or discourage people to spend. To boost spending, the bank imposes a negative interest rate on the money in everyone’s account – in effect, a tax on saving.

Faced with seeing their money slowly confiscated, people are more likely to spend it on goods and services. When this change in behaviour takes place across the country, the economy gets a significant fillip.

The recipient of cash responds in the same way, and also spends. Money circulates more quickly – or, as economists say, the “velocity of money” increases.

What about the opposite situation – when the economy is overheating? The central bank or government will certainly drop any negative interest on credit balances, but it could go further and impose a tax on transactions.

So whenever you use the money in your account to buy something, you pay a small penalty. That makes people less inclined to spend and more inclined to save, so reducing economic activity.

The first and most obvious failing here is that of privacy, liberty even. Who really wants the government (whether the political one or the State or the central bank) having a record of each and every transaction in the economy? The nothing to hide, nothing to fear line isn’t actually true we’re sorry, but it isn’t. That amount of information: that amount of control even. You can imagine the sort of horrors that would result. Seriously, how long before someone starts demanding that only 3 units of alcohol, 6 grammes of salt, a day and no more than one hamburger a week can be bought with that one, single, electronic account?

The second is that it is getting the point and purpose of the economy the wrong way around. We, us people, the citizenry, we’re not here to make the economy hum along. Having an economy that hums along is nice of course but it is to serve us, not the other way around. Thus imposing radical change upon us for the sake of the economy is simply nonsensical. It is to have the logic of the matter completely arse over tip.

And the third is that it almost certainly wouldn’t work to control the economy in the manner described. Because the usual cause of booms and busts is the authorities themselves getting those economic levers set to the wrong levels. We might argue this from Hayek’s point, that no one can ever know enough to set them to the right positions, we might borrow from Mancur Olson and point out that the State is, in reality (at least the people controlling it are) a stationary bandit. Much more interested in maintaining control through re-election than they are in the long term of the economy. This is why we always have a relaxation of monetary and fiscal conditions in the run up to an election: that’s just the way that it works.

In this reading the boom and the bust is caused by political control of those levers of the economy: strengthening that control really isn’t going to solve that problem.

As usual around here our objections are a mixture of concerns over liberty, morality and plain flat out cynicism about the political process. You can apply your own weights to these things but we worry most about the first and third.

Memo to the EU: markets work, capisce?

We’ve another of those stunning misunderstandings from Brussels about how this economy thing works. It’s not so much the European Union itself, it’s the mindset of the people that actually make the rules within it that matters. They’ve not got the idea that markets really do actually work. They’ve decided to set the fees that debit and credit cards can charge:

Consumers face cuts to the air miles, cash bonuses and other rewards they collect from credit cards because of a law passed in Brussels last month.

Capital One, one of Britain’s biggest card providers, has become the first firm to scrap the perks following new EU restrictions on the profits it can make.

In a statement the company said its cards, which paid customers up to 5p for every £1 spent, were “no longer sustainable”.

If you look at the fees in isolation then you might well think, hey, they’re making a lot, stop them! But to look at the fees in isolation is to be more than a bit of an idiot because markets really do work.

So, there’s those fees. And then those consumers who think they’re a bit high and would like to claw back some of that money get to do so. Because competition to gain those high fees means that card issuers start to offer cash back, air miles, discounts, freebies and other goodies. And what selection of freebies, discounts and other goodies people value most will influence their choice of card. Thus consumers get what they value most.

And now we fix the fees, to what in isolation might be regarded as “fair” and all those consumers then lose all of those compensating benefits. Because the people making these rules have looked at this in isolation, without noting that markets really do work and that card holders are already being compensated, in the manner they value most, for those seemingly high fees.

As we say, to look at such things in isolation is to be more than just a bit of an idiot.

Note that the profits that a card company can make are not being regulated. What is being regulated is the revenues one can have: and limiting the revenues that can be made also, inevitably, reduces the revenue that is rebated, leaving profits quite possibly unchanged. No overall benefit to consumers therefore but the tax leeches regulators feel they’ve achieved something.

This isn’t, despite the well known views of at least one of us here, a complaint about the European Union. It’s a complaint about the tax leeches regulators failing to understand that markets already achieve, without intervention, the things that the tax leeches regulators think that only they can bring about. The answer to which is, of course, more markets and fewer tax leeches.

Iceland’s new money and banking proposal. Yes, why not?

Iceland is considering a new report which would rather radically change the banking system of that country:

Iceland’s government is considering a revolutionary monetary proposal – removing the power of commercial banks to create money and handing it to the central bank.

The proposal, which would be a turnaround in the history of modern finance, was part of a report written by a lawmaker from the ruling centrist Progress Party, Frosti Sigurjonsson, entitled “A better monetary system for Iceland”.

“The findings will be an important contribution to the upcoming discussion, here and elsewhere, on money creation and monetary policy,” Prime Minister Sigmundur David Gunnlaugsson said.

The report, commissioned by the premier, is aimed at putting an end to a monetary system in place through a slew of financial crises, including the latest one in 2008.

To be honest, the report (which can be read at that link) is little more than a rehash of the proposals of Positive Money. And worth about as much as such a rehash is going to be. It’s worth pointing out that Julian Simon was actually correct, human ingenuity, and the knowledge it produces, is the ultimate resource. And given that Iceland’s population is some 300,000 people there’s not a great deal of it natively. We have noted around here more than once the problems that stem from trying to extract decent economic ideas from the rather larger population of Norfolk as an example.

The basic idea is that as banks create credit, credit creation is behind boom and bust, put credit creation into the hands of the government and abolish boom and bust. We don’t think that that’s how it will work out. Rather more likely is that politicians will follow the incentives of being able to spend this newly created money without having to tax to gain it and the result will be high and persistent inflation.

However, we’re absolutely delighted that someone undertakes the experiment. Actually, we’re delighted that someone else undertakes this experiment. Good luck to them say we. And we’ll come back in 20 years, see whether there’s been that abolition of boom and bust, been that persistent inflation or not, and then we can make a decision about whether to follow or not.

An interesting view of what bankers actually do

It’s a commonplace in the public square these days that bankers are the evil ones, designing odd products like a CDS or CDO, to trap the unwary investor into parting with all their worldly wealth. and then there’s the occasional expression of a more obviously sensible view, as in this one about Islamic banking:

Many of the instruments Irfan discusses were sold by major banks that saw them as just another opportunity. This is not surprising: Governments and wealthy individuals wanted financing that complied with their religious requirements, and banks gave it to them. Irfan, by contrast, longs for an Islamic finance industry that caters to “small and medium-sized enterprises, retail customers, the man in the street” and offers something “beneficial to everyone, irrespective of creed.”

The actual book is about Islamic financing, a subject we find quite fascinating. For of course the basis of said Islamic financing is an outright denial of something that we hold to be an obvious truth: there’s a time value to money. That there is is what leads to there being an interest rate and also to all those other techniques like discounting to get to net present values and so on. We take these to be simply obvious truths about the universe that we humans inhabit and one can, as experiments have, derive the existence of that time value by studying small children. A baby doesn’t get the idea of delayed gratification for greater gratification, a three year old will usually grasp the idea of two sweeties tomorrow instead of one now and a 6 year old might go for two in a week for one now. This is an interest rate and it does seem to be innate in human beings.

So, obviously, it could be seen as a little odd that we not only enjoy but thoroughly approve of these various Islamic alternatives. For they all (things like Sukuk bonds and so on) depend upon the absolute rejection of interest, that very thing that we insist is part of the fabric of our reality. The reason we so like Islamic finance is because all of he successful forms of it are actually constructs that, in the face of the religious insistence that there should be no interest, actually operate in a manner to ensure that there is a time value to money and that there is an interest rate, interest which has to be paid.

Which brings us back to what we liked about that description of banking: they bankers are simply providing what their customers want. Seems a more honest trade than many to us, enabling someone to meet their religious obligations while still saving for their old age and the like.