by Aaron Krowne
This past year has seen a resurgent interest in state (or public) banking as an answer to many of the ills displayed in our banking system in the wake of the credit crisis. I’m happy to see this, but concerned that there may be too many naive proponents of public banking that mistakenly see it as a “total” solution.
Ellen Brown, author of “Web Of Debt”, is the leading proponent of public banking. In addition to her book, she has been writing online articles for years promoting the idea. More recently the idea has started to catch on, in my opinion, nudged by the obvious dismal results of our central bank/money center cartelized banking system.
Public banking is little more than government-owned and managed banking. It still is based upon the same fiat money system that is today’s dollar, as well as all major world currencies. Like private banks, public banks also use “fractional reserve”.
While fractional reserve lending and fiat currencies are fundamentally unsound, the benefit of public banking is firstly that the state can manage its own finances, and to some extent fund itself, from its own bank. Not only does it pocket the profit from its own cash deposits, it can also use the state bank to finance public works projects, grants and other subsidies. In general, it can direct lending towards the general welfare, rather than being beholden to foreign interests, who tend to act more predatory by virtue of lack of community presence (as well as lack of jurisdictional policing).
From the perspective of a US state, these “foreign interests” include Wall Street, as well as the behemoth commercial banks (like Bank of America) — which is certainly not an immaterial point.
Brown typically points to the Bank of North Dakota her central example. Its hard to deny that this state bank seems to be run pretty well, and is doing the state a lot of good, at least compared to Wall Street. However, when discussing this example, Brown typically argues by association that the state’s balanced budget and relatively strong economy (in terms of unemployment) are somehow direct results. I find this doubtful, given, for instance, that North Dakota actually produces an energy surplus (It is one of only a handful that does), and has an extremely low population, leading to inherently lower costs of government. Such factors are not minor when considering why a political entity has a strong economy.
But all that aside, I still concede that public banking may be beneficial in circumstances such as North Dakota’s. What I object to are polemics that begin with California’s budget crisis, and immediately proceed to a discussion of the virtues of public banking in North Dakota, as if the two are interchangeable.
The two might as well not even be on the same planet. Again, ignoring the small scale and difference in energy balance (despite having significant energy production, California imports way more than it produces), California is deep in the red ink already. It rankles me to see things like Bank of America having the audacity to refuse California’s “IOUs”, but a switch to public banking, all other things equal, will never in a million years solve California’s problems. That’s because California has a deeply-entrenched political culture of deficit spending — or more fundamentally, total ignorance of the notion of a balanced budget. The various lobbies are too deeply entrenched. Even “The Governator” did little more than borrow from the future (and even from localities) to avoid dealing with the problem.
I suspect a switch to public banking in California, to any meaningful extent, would mean an instant inflationary firestorm. Remember, the public bank is managed by the government of its jurisdiction, so we’re talking about Sacramento here… having control of the soundness of lending. And we’re talking about the state which is home to the CALPERS public pension fund, which is so obviously mismanaged, even I was calling it in advance on multi-billion dollar errors half a decade ago (such as when it allowed homebuilder Lennar to dump unwanted raw land on it at the peak of the housing bubble — at bubble prices). Not surprisingly, criminal corruption in CALPERS’ governance has since surfaced, but this sort of thing is endemic to the allocation and spending of big blocks of money by large governments with little meaningful oversight. Even when conduct is not provably criminal, it is much more often questionable… and more importantly, non-economic.
Brown takes the public banking theme farther in her most recent article, in which she upholds the virtues of Japan’s public bank, the Post Bank (in essence, Japan’s post office and its public bank are one, a shrewd idea, if one is to have both institutions in a state). She argues against the long-planned but endlessly-postponed privatization of Japan Post Bank, suggesting that the current crisis will create a powerful urge to push that privatization forward, presumably to raise quick cash for rebuilding efforts and to plug other financial gaps in the Land of the Rising Sun. Brown thinks this urge should be resisted.
This may be. Perhaps totally privatizing the Post Bank would be a bad idea. But I feel compelled to observe something important Brown mentions in her own article: that the Post Bank has become a venue of politicized “white elephant” spending, to an increasing extent, as Japan has sought to prop up its economy in the wake of the 1990 market crash. It never recovered from this crash, having been in veritable stasis since then, with real estate prices drifting endlessly lower. Japan’s debt is now 200% of GDP, a world record, and shocking for a modern, developed nation.
As Brown points out, the Post Bank has made handy to the government a huge chunk of the savings of its people. The national government can then mobilize this money for its political pet projects, with no need to go through a budgetary appropriations process. Essentially, a captive lender for the political regime. As mentioned, all of this has failed at the putative policy goal, bringing the Japanese economy back to healthy growth. In my opinion, it is a gross misappropriation of the savings of a people. Its not exactly like the public funds held in Post Bank savings have been mobilized to revitalize the economy, say with intelligent small business lending. Instead, the Post Bank seems to have simply served as a stand-in for more Quantitative Easing (money printing to buy government bonds and other securities deemed to be To Big To Fail), and thus given Japan a longer rope with which to hang itself. The ultimate consequences are still forthcoming.
So, something certainly needs to change. Perhaps not privatization — the Post Bank could implement more punitive interest rates, freeing the funds to flow out into other areas of Japan’s economy. That might be hard to do, with near-zero interest rates, but there undoubtedly are ways. At any rate, this serves as a handy example that is is even more extreme than California, and shows how essentially nationalizing the majority of a country’s savings through a public bank is likely to lead to a sclerotic economy.
As I mentioned, California’s woes if it were to try something like this could be even worse, resulting in run-away inflation due to the sudden release of funds into the state economy. In my opinion, Japan has only avoided this fate by allowing the Yen to be “carry traded” into other countries with higher-yielding banking systems (and that will probably start to run into reverse soon, putting Japan at risk of hyperinflation). The big “carry trade” originating from the US has been into commodities, and that simply makes the inflation situation worse.
So what’s the answer? Besides keeping public banks limited and prevented from “eating up” the entire banking system, we need sound money. As in backed by gold and/or silver.
To see why, I think one needs to look at the real root of the problem. It’s not just that the big banks are inherently evil. They certainly have natural and regulatory incentives that have made them very predatory. But I think the foundational problem is not simply Big Evil banks, but rather, an artificial need imposed upon regular people to stash their savings in fundamentally unsound banks for lack of a better alternative.
Back when the dollar was backed by gold and silver, banking was a more rare thing. Fundamentally, that’s because sound money is its own wealth-preserver. This is the key to understanding why the US economy was more stable even though banks could still lend out fractional reserves (in essence, “printing money” for themselves) — they always had to compete with the raw ability of depositors to simply withdraw their cash and go into precious metals — the dollar used to explicitly be a bailment reciept for a certain quantity of gold or silver, not to mention that “small” change was in the form of gold and silver as well.
Cheerleaders of fiat money constantly point to the bank failures and panics of that era (pre-1914, and to some extent, pre-1971), but rarely observe that bubbles and financial failures have become even bigger and more economy-wide since then. But driving the point home hardest, nothing rivals the loss of public wealth intrinsic to the housing bubble. And it is impossible to deny that the root cause of that debacle was that housing became, as a matter of public policy, the de facto “wealth preservation” vehicle of the general public. It was like normal savings banking on steroids, then on crack.
Gold would have obviously been a much better value-preserver over the same period (2001 to present), but the government taxes it at a punitive (28%) “collectibles” rate, while for most of the public, housing has been made tax-free in terms of capital gains, and tax free on interest. Few investment options enjoy that privilege. In fact, over the 2001-2010 period, the public enjoyed the “Bush Tax cuts”, which moved all capital gains to 5% and 15% brackets. Gold and other precious metals were not included, left in the Draconian 28% ghetto.
This is all especially unjust considering that in the long run, gold simply preserves value, while fiat money intrinsically inflates away to nothing. So with any amount of precious metals taxation, you are simply paying taxes on inflation. It’s actually a lot like a shadow property tax — but on real monetary wealth.
And here’s the genesis of the Big Problem: the flip side of such a tax is that it incentivizes speculation… to stay ahead of the rising tide of inflation and taxes. Naturally that moves people into areas offering the highest “safe” yield, and the best tax advantage. Cue housing and exotic mortgage-linked investments.
But it goes beyond housing — this is really the structure and nature of the whole financial system in fiat-based central banking. FDIC makes the problem even worse, by totally eliminating any incentive to hold cash or other wealth-bearing assets outside of the bank. Or even a specific bank. A notorious effect of deposit insurance is that troubled institutions will tend to offer ridiculous yields on deposits, which will attract yet more depositors because they know the government will just step in and bail out their accounts in the case of insolvency. This becomes a feedback effect whereby banks become even more insolvent through doubling-down on poor investing, and attract ever more deposits, in true Ponzi fashion.
Sound money provides a competitive pillar to the banking system. Since money itself can store wealth in such a system, any investment or financial institution has to compete with that concrete basis. Without it, the entire financial house of an economy is built on the shifting sands of fiat. Over time, this system becomes even more politicized, leading to the “Too Big To Fail” mantra we see today, Quantitative Easing (the modern equivalent of money printing), and ultimately currency collapse.
And public banking, incidentally, won’t solve any of this.