On Thursday night I went to the LSE to hear a lecture by ProfessorHuerta De Soto followed by a dinner discussion with interested parties including Douglas Carswell MP and Stephen Baker MP. They have tabled a bill to outlaw fractional reserve banking, the practise that allows banks to lend most of the money they collect in deposits and only keep back a fraction of it to repay depositors on demand.
I agreed with much of the Huerta De Soto analysis of what had gone wrong in the bubble and Credit Crunch. Like him, I have argued that bad Central banking lay at the heart of the crisis. I found it more difficult to agree with his remedies, which envisage a completely different structure of banks dependent on a currency linked to gold.
The conversation included some barbed and interesting exchanges between Austrian school devotees and UK establishment neo Keynsian and neo classical economists. The Austrians worship at the shrine of Hayek and are angry at the way in which conventional economics faculties ignore their great man’s work. Their thinking can take them to the point where they want to abolish fiat money, Central banks and much of the apparatus of the present democratic states. The Establishment economists are happier arguing over relatively minor adjustments within a system which may be collapsing, reluctant to see that their chosen remedies may be washed aside by the huge structural and monetary changes unleashed worldwide.
The Austrian bank reformers want every pound of deposits backed by a pound of cash. This removes the need for a Central Bank acting as lender of last resort, and makes a run on a bank impossible or pointless. It would also mean a big contraction in credit, and more difficulties for the small saver in getting a decent return on his savings. They seem a little light in thinking through how they would accomplish such a huge change without too much economic disruption.
If you link this reform to a restoraiton of the Gold Standard, as Professor Huerta De Soto recommends, you add another layer of complexity and change. You enrich countries like South Afirca which mine the metal, and countries like France and China which have been buying it up. Inflation or recession are then linked to how much gold is mined compared to the natural growth of the world economy. You replace the capricious judgements of governments over how much money to issue with the cycles and business plans of the mining industry.
Banking reform is in the air, and rightly so. I don’t think the UK establishment is about to welcome Mr Carswell’s Bill, nor about to seek the gold standard just a few years after the Uk foolishly sold a lot of its gold reserves. We need to discuss improvements to UK and world banking that can deal with some of the manifest problems of poor Central banking 2005-9 that could take root and be adopted.