Monday, 1 February 2010

Just a Thought….

You may not know this but the Bank of England is the only institution that has the authority and therefore the power to destroy our currency.

Interestng? But to understand how, you have to understand the power it has. This power is used to lend money or accept deposits at a defined interest rate with the aim of controlling the economy’s growth and inflation levels.

But alas not everyone can borrow from the Bank of England; it only lends to other banks or building societies (the few that are left anyway) and even then only over a few fixed (and usually very short) time periods. If a bank wants to borrow or deposit money for a different length of time, or needs more flexibility on how much and when they borrow and lend, then they have to go to another bank. However the rates the banks lend to money to each other as defined by London Inter Bank Offered Rate (LIBOR) are of course higher than the Bank of England’s rate as other bank’s can’t actually produce their own money and so may not be able to pay back or get back what they borrow or lend respectively.

Banks make a profit by lending money to other companies and individuals (including other banks unable to borrow from the Bank of England) at rates higher than LIBOR and credit their depositors with lower rates. No surprise there of course.

Ergo; the economic laws of supply and demand and risk and reward of course come into play.

But what if Britain didn’t have a central bank, what if we just scrapped its function?

If no one i.e. government or an institution such as the Bank of England could “create” money and there were no (effective) controls over growth and inflation (setting interest rates) then Britain’s net imports may eventually lead to a shortage of actual pound coins so to speak to pay for them, people would be forced to use another currency for day-to-day business. However, if the money controls were too tight, exports would be hurt as international investors would find it hard to get the money needed to buy British goods. We would therefore need a way of creating new money?

Therefore with no central bank, and therefore no variable monetary policy, the value of a pound would have to be fixed relative to another currency or one or more goods such as say Gold. As the government could only provide new pound coins when the appropriate deposits were placed with it, inflation therefore would only depend on the changes in value of the deposits.

In an economic downturn such as we’ve had, credit as we have seen is harder to come by even despite quantitative easing but with no central bank there would be no infinite supply of money such as we’ve seen supporting the banks and financial sector.

Banks would however still lend money as they need income (to pay shareholders!) but they would be far more selective in whom they loaned to.

Demand for credit would quickly outstrip supply, bankrupting unprofitable companies and halting unsustainable lifestyles fuelled by the big bonus cultures splashed over the MSM.

I have argued before that the banks should have been allowed to fail when the credit crunch hit, their model of doing business is archaic and is frankly broken, their practices are all too indicative of a monopoly and if the lessons of history on monopolies are to be learnt to avoid the decay and corruption we’ve seen why wasn’t this allowed to happen?

The money we waste in treating this terminally ill dog could have been saved by putting them to sleep (depositor protection was in place anyway but could easily have been ‘beefed up’ at a fraction of the cost in billions that have been squandered so far on propping up institutions that will eventually die anyway) We then would have seen healthier financially sound banks and financial institutions step into the void (as the supermarkets are doing now) and we I believe would have come storming out of recession with growth figures well beyond the paltry anaemic 0.1% farcical figure we’ve seen so far.

If the government had had the foresight to keep a steady hand on the tiller, instead of panicking as they had done when this storm hit then this “managed” reduction in private and public debt would actually have speeded up the process of growth within the economy.

Instead Alastair and Gordon think borrowing more money and wastefully spending it is the way to borrow and spend your way out of debt! is it any wonder were the last G20 country to officially come out of recession?

Unlimited sources of cheap credit as we have seen has fuelled many asset price booms (the current one even more so supported by quantitative easing). Without the Bank of England, the amount of money a commercial bank could lend would then be limited by its deposits (much like the original principles building societies were formed under). It is a simple truth that during booms speculators withdraw their deposits and take out loans and combine these to invest in booming assets (i.e. property is one good example where we have seen the effects) and so with no central bank the laws of supply and demand would then limit the extent of a boom by driving up the cost of credit!

Many countries experience tremendous growth and stability without the aid of a central bank – would Britain be better of too without one?

Just a thought……


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