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State Banking Is Not Enough For A Stable Economy: Sound Money Is Needed

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.

There Are 7 Responses So Far. »

  1. Ellen is right, publicly owned and/or state chartered banks are greatly needed to de-couple from the Wall St and Federal Reserve Bank of N.Y.

    The question becomes, how should they operate – what should be their goals? The potential is incredible, for example, consider this:

    1) 97% of the open mortgages in the U.S. are GUARANTEED by the government

    2) This is the largest segment of private debt totaling over $14 trillion.

    3) The public, through state and locally owned/chartered banks, could make 0% mortgages available to qualified borrowers.

    4) Transaction fees and services could provide a positive cash flow through the system to more than pay for expenses.

    5) 0% mortgages reduce the payments by around half (assuming a 5% traditional mortgage)

    4) On average, 26% of household income ends up in mortgages repayments. That means the average household would receive a combined 10% raise in income kept.

    Ellen Brown is one of the few stepping forward with non-Washington solutions. De-centralization is direly needed.

    You invoke the “fiat money” boogeyman but miss the entire point. It is not the specie of money that is the problem – it is an interest bearing debt money system!

    It is created by debt and destroyed as the principal is repaid to a creating bank. All of our money is temporary, and if it were backed by gold, it would still be temporary. You are far better off buying private PMs and using them to store your wealth. If you have PMs; you shouldn’t use them in transactions as long as you have Federal Reserve Notes, credit cards and bank account money.

    You mentioned insider control of the public banks and I agree that is a challenge. For example, the Bank of England was nationalized but it is still privately controlled through an un-accountable group.

    I think the answer may be that the banks should neither invest money nor pay interest on accounts. Borrowers could pay the required capital ratio fees to keep the bank solvent while providing 0% loans to qualified borrowers as long as they are fully backed by collateral.

    Maybe you or other contributors to this thread can offer other ways for public or state chartered banks to pass “quantitative easing” (0 or near 0% interest rates for banks) to the people!



  2. Hi Larry,

    I can’t believe you actually read my article; about the only thing in your comment I agree with is the need for more decentralization. I think that is key, with sound money being the ultimate decentralizer (in a sense, it makes each individual their own political unit, or sovereign).

    But you totally gloss over the problem of swapping one set of abusers and mismanagers in private banking with another in public banking. I don’t see any reason to trust government more than private agents, particularly when the former is the one with the legal force of confiscation; the latter can only acquire anything approaching that force at a great effort, typically with cartelization or monopolization. But I think it is pretty evident that the best outcome derives from a healthy competition between various fundamentally-different forms of banking… and money.

    I also think you missed the point by calling for “0% interest rates to be passed on to the people”. What you’re essentially calling for is direct monetization of society’s fiscal problems; money-printing… i.e. inflation. That is always a negative-sum game; society as a whole loses. I agree it is unfair that big banks are getting access to the 0% rates but society as a whole is not; but two wrongs do not make a right. The artificially-low interest rates are a ruinous distortion of the economy and should be eliminated entirely, with interest rates set by the free market… in competition with sound money.


  3. Aaron is right in his response to Larry. His analysis is consistent with the extensive economic theory provided by the Austrian school of economics. A good resource to learn about these issues is Rothbard’s “What Has the Government Done to Our Money?” available online for free here:


    which I recommend to Larry.


  4. You speak well in favor of public banking: “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”.
    You’re right, right off the bat states can save billions of dollars in interest payments to private banks because they will be paying the interest to themselves since they own the bank. They can save 50% of the costs of public works projects, and that’s just to start. It’s what you call efficient. Why throw state money away to private banks? State banking is so advantangeous, it’s a no-brainer. North Dakota has done it responsibly and so can other states. California can reap such instant real advantages from a state bank, it’s criminal not to do it. Your “instant inflationary firestorm” claim is ludicrous. The present financial situation of states is unsustainable and the big banks caused it. States need to do something positive financially for themselves and state banks are an obvious step: become more financially efficient by cutting out the middle-man.
    The fact is that private TBTF banking has failed miserably, needing 14 trillion in public funds and guarantees – welfare money – and ruining our economy in the process.
    As for Japan’s Postal Bank, your comments make me think you did not read Ellen Brown’s article. The reason that Japan’s debt is no big deal is that it owns the bank and owes most of it to itself. That it spent lots of money on infrastructure projects is no big failing. The fact is that Japan stabilized at a very high level of economic achievement after 1990. That it has not been doing well economically is a misconception. See this article http://www.paecon.net/PAEReview/issue23/Locke23.htm.
    To compare Japan Post investing citizens’ savings in infrastructure and industry to QE1 and 2 where the privately owned Fed dished out hundreds of billions of phony money to the parasitic banksters is ludicrous.
    You say that “nationalizing the majority of a country’s savings through a public bank is likely to lead to a sclerotic economy.” But you’re wrong. JP provided the funding for the Japanese economic miracle after WWII, the German publicly owned Landesbanken funded the German economic miracle (40% of Germany’s banking is still publicly owned), Korea’s economic miracle was done through public banking, so was Taiwan’s. Check out Ha-Joon Chang’s Bad Samaritans for more facts.
    Public banking is not dangerous and is something that states should try. It is a good solution, not for everything, but it makes sense.
    Readers can get a more balanced historical view of your “gold is money” religion by checking out this article http://webofdebt.wordpress.com/chapter-37-goldbugs-and-greenbackers-debate/ and if they really want to get educated they can read Ellen Brown’s book Web of Debt.

  5. “Ernie” — You write your comments with vitriol as if I was seeking to eliminate public banking as a possibility and even a major player in any healthy banking ecosystem. That is obviously not what I was saying — my point was to illustrate that it is not a “total” solution, to the complete neglect of other banking/monetary improvements that its proponents typically display.

    I also find your insouciance regarding the economic problems in Japan to be distressing. The fact that you made such statements in the wake of the Fukushima disaster should embarass you. If that does not illustrate shoddy infrastructure problems underneath a “high tech industrialized” veneer, I don’t know what does. In reality, Japan, as well as Taiwan, Korea, and a number of other Asian economies suffer from top-heavy conglomeration and cartelization that has weakened and stunted their economies. I consider Japan’s public banking to be a contributor to their problems, having helped fund questionable infrastructure priorities, starving the private economy of funds. But perhaps it would not necessarily matter much, with the industrial and banking conglomerates having evolved to little more than extensions of government.

    I’m not sure where you’re gleaning anything about a “gold is money” religion. Obviously gold has a major monetary role; we can argue all day about whether it is “real” money or “better” money than intrinsically irredeemable currency, but that is of little consequence. The truth is, the market demands it, and to deny this is to suppress a major portion of the market. I think there is a clear need to re-mobilize gold as money into the economy, and these days I am not alone in that view — I hardly think that current Fed board members, the head of the World Bank, and Bill Clinton are “gold bugs”. So you are attempting a common straw man argument and/or ad hominem smear with this one.

    I agree that TBTF banking has been a failure, but not only did I not advocate it in my article, I spoke out against it.

    I hardly think that running its own bank is going to solve the deep deficit problems of most US states, particularly California and Illinois. The problem is that the money is simply not there. The private market is correctly not lending to insolvent governments; to the extent they are, the risk has simply been pushed onto the Federal government in the form of Build America Bonds and other myriad stimulus monies (which we also don’t have). So, if you are implying that public banking will solve most of this, that is an admission that the state will simply find a way to print most of the money. I don’t see how that isn’t inflationary. I don’t give deflationists a lot of credit, but it is certainly the case that holding back on some of this state spending has, at the least, spared us much more significant inflation.

    What is really needed is a more vibrant consumer/private economy in terms of finance. Public banking may be a part of that, but (as I argued) private banking and sound money offer advantages it is impossible for public banking to replicate. Without them, I doubt we will see state economies come back to the point that they get out of their deficits (the only truly sustainable way to do so).

  6. The public banking model can be applied to states and even counties. In Miami Dade County, Dr. Farid Khavari is running on a platform that would introduce a county public bank. It would be operated by professional, qualified citizens chosen at random, not by political appointment. By keeping a strong system of checks and balances, political influence can be prevented.

    The county’s property taxes would be deposited in the bank, which would then engage in prudent, local lending inside the community. With many homes underwater, the bank would help its citizens refinance with 2%, 15 year loans. People would pay less in interest on the life of the loan and own it within 15 years.

    The purpose of the lending activity would be two fold. First, the profits of the bank would go to lowering, and then eliminating the county’s property tax. Secondly, the lending would be directed at opportunities that “lower the cost of living”.

    These could include: home weatherization (with quantifiable payback times), businesses offering energy cost reducing solutions, and government infrastructure projects showing quanitifiable cost reducing results.

    By reducing energy and interest costs in a complex economy like Miami Dade’s, more and more capital will be available for circulation or for savings. Businesses would benefit from the stronger, more confident consumer. And the positive cycle would continue.

  7. The already proven answer was tried and proven by young President
    “JOHN-F-KENNEDY.NET” (From the internet).

    His EXECUTIVE ORDER 11110 is still very viable and “waiting!”

    Silent Searcher

    Wise young President Kennedy solved the money obstacle by issuing EXECUTIVE ORDER 11110 to bypass the unconstitunal Federal Reserve Notes, with interest free, United States Notes in $2 and $5
    values. over 4 billion were put into circulation. His next move was to order the Treasury Department to print $10 and $20 dollar
    bills. Before they could be put into circulation. Read following from the internet:



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