[A-List] More Detail on the Proposed BOE Act - Part Ten
shimogamo at ashisuto.co.jp
Fri Aug 20 03:03:02 MDT 2010
Note: This is the tenth and last part of a series filling in details of
the Proposed Bank of England Act on which I posted seven articles here
from July 31st to August 3rd. Bill Totten
Overdrafts & General Liquidity in the System
Liquidity in the Post-Reform Banking System
This reform reduces the amount of 'credit' - or more accurately,
lending - available in the economy, from around 100% of the existing
money supply to around fifty to sixty per cent. Considering that the
authorities focussed on the 'credit squeeze' as the biggest problem in
the recent financial crisis, the idea of significantly reducing the
amount of available credit (lending) raises alarm bells for many people.
However, most of these concerns stem from an incomplete understanding
of how the monetary system works. The reality is that our dependence on
credit is not a natural aspect of the economy - it is a direct result
of allowing banks to create the nation's money as debt. When 97.5% of
the existing money supply was created as debt, and is therefore earning
interest, it creates inflation (especially in housing) that
necessitates people borrowing more simply to survive.
Before we explain why a reduction in credit (lending) will not be a
problem after the reform, we need to clear up a few misconceptions
about 'credit', 'debt' and 'lending'.
Credit = Debt
The term 'credit' is used misleadingly. 'Credit' has positive
associations - everyone wants a good credit rating, and your salary
appears in your bank account under the 'credit' column. But in this
case, 'credit' means 'debt'. If we say that businesses depend on access
to credit, we are saying that that their financial situation is poor
enough that they urgently need to go into debt. Of course, very new
businesses and businesses which are expanding rapidly will need access
to credit/debt, but the fact that many businesses will go bankrupt as
soon as banks stop offering them further debt points to the poor
financial health of most businesses. This poor financial health is not
the natural state of affairs - it is a symptom of a monetary system
where all new money is created by the banks.
We Are Dependent on Credit/Debt
Because Our Money Supply IS Debt
The absolute dependence on 'credit', and the fact that the economy
grinds to a halt whenever 'credit' dries up, is used to point to the
importance of credit in a modern economy. In reality, it points to a
chronic shortage of debt-free money in the economy. By definition, if
the economy needs 'credit' to continue functioning, we are dependent on
Over the last few decades we have all become accustomed to having total
debts equal to five or six times our annual salary, and businesses
having debts as much as their annual turnover. However, this is not a
natural state of affairs - it is a product of a system where almost all
money only comes into existence when someone takes out a loan.
This means that, while economists argue that easy access to credit is
essential to a well-functioning economy, in reality, dependence on
credit is a symptom of a malfunctioning economy and a malfunctioning
money supply. The debt-based monetary system actually creates the need
for companies and households to access credit (debt). In other words,
we are all so far in debt because we allow our money to be created as
The answer to our debt-dependency is not more debt (despite political
leaders shouting "Let's get banks lending again!") but newly created,
debt-free money, which can help to cancel out the debt and reduce our
As Debt-Free Money Cancels Out the Debt,
We Will Have Less Need for Credit
As we create and inject debt-free money into the economy, this will
allow individuals and companies to gradually pay down their own debts
and start to increase their savings. With great savings, people have
less dependence on debt, and therefore access to credit (debt) becomes
less critical to the health of the economy.
As the Amount of Credit Falls After the Reform,
Demand for Lending Will Also Be Falling
The amount of credit/lending available after the reform may gradually
fall to around fifty per cent of the current level. At the same time,
newly-created money will be injected into the economy, not as a debt
into the housing market, but as tax cuts, tax rebates and government
This newly created debt-free money provides a stronger stimulus than
debt-based money created by the banks, since there is no need to pay an
interest charge on the money as soon as it is created. As a result, the
economy should improve, and people will be better able to pay off their
existing debts, pay down mortgages, and improve their financial
position. With lower taxes and a more buoyant economy, the need to go
into debt will fall and apply to fewer people. In other words, the
demand for credit will fall in tandem with the availability of credit.
If there are any shortfalls in the amount of credit available during
the 'transition' phase between the two systems, these can be met by the
Monetary Policy Committee choosing to create more money (if all the
other economic indicators also point to the need for more money), or by
lending money directly to banks on the condition that this money goes
into 'productive' lending - funding businesses rather than consumer
credit cards, for example.
Ensuring Liquidity Through Overdrafts
Overdrafts on Transaction Accounts can play a key part in the
post-reform banking system. Firstly, they will provide a short-term
'liquidity buffer' to households and businesses. Secondly, they will
provide a very useful indicator on the need for more (or less) new
money to be injected into the economy.
'The Liquidity Buffer'
Overdrafts provide short-term liquidity and allow businesses and
individuals to smooth out temporary mismatches between their incoming
and outgoing cash flows (for example, if an individual's bills need to
be paid just a few days before their salary is paid into the account).
There would be no advantage to the bank, to the customer, and to the
economy as a whole of removing the overdraft functionality from
Indicating Changes in the Need for Money in the Economy
The balance of one overdraft may fluctuate wildly through the month and
at different times in the year. However, averaged over millions of
Transaction Account holders, the average balance will be fairly stable.
This means that changes in this average balance will indicate
significant changes in the economy. If this average balance is
increasing (that is, people on average are going further into their
overdrafts) then it indicates that people do not have enough money to
meet their regular expenses, and could therefore mean that the economy
needs a greater injection of new money. On the other hand, if average
overdraft balances are falling (people are - on average - paying off
their overdrafts) it could mean that there is 'spare' money in the
economy and point to the possibility of inflation in the near future.
How Overdrafts Will Be Funded
It is suggested that overdrafts can be funded via borrowing from the
Bank of England. The banks will pay a rate of interest on these funds.
Rather than the interest rate being set by the Bank of England, it can
be set via 'market forces' through auctions between the banks.
Recognising the importance of overdrafts in providing liquidity to the
economy, it is suggested that the funds used for overdrafts should come
not out of existing money, but be funded via newly created money. This
would allow overdrafts to act as a type of 'float valve' to allow
relatively small and temporary changes in the money supply of the
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