“MOST of what we call money is actually short-term debt created by banks when they make loans. This means that banks are the stewards of our savings and manage the payments system. As a result, they have a privileged place in our society: governments never deliberately choose to liquidate the banking system. It always appears preferable, in the short term at least, to preserve the incumbent institutions and personnel through bail-outs. (Lending to “solvent but illiquid” firms at below-market rates is another kind of bail-out, even if it is not always called one by the authorities.)”
I think it’s incredibly important to understand that first point. Almost all of what we call “money” today is created by banks out of thin air. The government has essentially outsourced money creation to an oligopoly of private entities. This might sound ludicrous, but it’s largely in keeping with the capitalist nature and democratic foundings of the American system. That is, the money supply is controlled not by the government, but by the private sector. And the entities that distribute this money must compete for our business. The alternative is having the government distribute all money in some fashion.
Of course, the problem with this design is that private banks are driven purely by the profit motive. So, this capitalist design can be both beneficial, but inherently unstable as banks have a tendency to reach out on the risk curve. It’s the old Hyman Minsky “stability creates instability” thing. So you have a serious conflict of interests here. The banks issue and dominate the social construct that is OUR money. And their involvement in the stability of that social construct is essential as they maintain the payments system. But the profit motive leads them to do silly things at times which leads to systemic instability.
Matt’s article discusses the need for higher capital requirements and reining in the ability of banks to take massive risks. I’ll stop blathering and let you read it….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.