Do we Need Central Banks?

Do we Need Central Banks? By Richard Werner.

For more than the past four decades, public policy discourse, especially when touching on macroeconomic and monetary policy, has been dominated by the views held and actively sponsored by the central banks, particularly in Europe and North-America, as well as Japan. Their policy narrative has been consistent over time and virtually identical between central banks …

We are all familiar with parts or all of this central bank narrative, even if we are not trained economists or not commonly interested in economic issues: This is because this narrative has been repeated ad nauseam hundreds of times in the past four decades.

As a result, even astute observers assume that empirical research has long established [the five central] insights from the central bankers, in uncountable meticulous quantitative research studies.

Central banking policy was revealed as a failure by the events of the GFC and what has followed.

But this is not the case. The truth could not be further from it: There is in fact no empirical evidence to support any of these five claims. They are mere assertions. Claims that have, in fact, been disproven by the facts. There is overwhelming evidence to the contrary, and this has become increasingly obvious since the 2008 financial crisis. …

After centuries of obfuscation, few people know how banks actually work. Banks make the vast bulk of loans from newly manufactured money (“bank credit”) — made by simply by typing a number into a computer, constrained only by the Basel Accords on how much they can create. They then charge interest on this money that they created of thin air. Good business model, eh? There are rules and constraints of course, but notice that bankers are wealthy without working hard.

In 2014, the first empirical study on how banks actually work was finally published (followed by a second study in 2015) and thus ended the centuries’ old debate …

The empirical tests rejected the financial intermediation and fractional reserve theories and showed that banks do not need prior savings, nor central bank reserves or other deposits to lend. Instead, banks create new money when they do what is called ‘bank lending’, and add it to the money supply. Bank loans thus do not transfer existing purchasing power, but add net new purchasing power. The [private] banks’ lending creates 97% of the money supply. Bankers’ decisions about how much money is lent — and thus created and added to the money supply — and given to whom for what purpose quickly reshapes the economic landscape and affects us all. …

Markets are never in equilibrium. Don’t be fooled by prices, but consider quantities — the short side exerts the power.

On our planet earth — as opposed to the very different planet that economists seem to be on — all markets are rationed. In rationed markets a simple rule applies: the short side principle. It says that whichever quantity of demand or supply is smaller (the ‘short side’) will be transacted (it is the only quantity that can be transacted). Meanwhile, the rest will remain unserved, and thus the short side wields power: the power to pick and choose with whom to do business.

Examples abound. For instance, when applying for a job, there tend to be more applicants than jobs, resulting in a selection procedure that may involve a number of activities and demands that can only be described as being of a non-market nature (think about how Hollywood actresses are selected), but does not usually include the question: what is the lowest wage you are prepared to work for?

Thus the theoretical dream world of “market equilibrium” allows economists to avoid talking about the reality of pervasive rationing, and with it, power being exerted by the short side in every market. Thus the entire power dimension in our economic reality – how the short side, such as the producer hiring starlets for Hollywood films, can exploit his power of being able to pick and choose with whom to do business, by extracting ‘non-market benefits’ of all kinds. The pretense of ‘equilibrium’ not only keeps this real power dimension hidden. It also helps to deflect the public discourse onto the politically more convenient alleged role of ‘prices’, such as the price of money, the interest rate. The emphasis on prices then also helps to justify the charging of usury (interest), which until about 300 years ago was illegal in most countries, including throughout Europe.

However, this narrative has suffered an abductio ad absurdum by the long period of near zero interest rates, so that it became obvious that the true monetary policy action takes place in terms of quantities, not the interest rate. …

Thus it can be plainly seen today that the most important macroeconomic variable cannot be the price of money. Instead, it is its quantity. Is the quantity of money rationed by the demand or supply side? Asked differently, what is larger – the demand for money or its supply? Since money – and this includes bank money – is so useful, there is always some demand for it by someone. As a result, the short side is always the supply of money and credit. Banks ration credit even at the best of times in order to ensure that borrowers with sensible investment projects stay among the loan applicants …

The banks thus occupy a pivotal role in the economy as they undertake the task of creating and allocating the new purchasing power that is added to the money supply and they decide what projects will get this newly created funding, and what projects will have to be abandoned due to a ‘lack of money’.

The central banks want to squeeze out private banks and take over money production themselves. This is positively Orwellian, centralizing the production and management of money to just a few central banks.

The job of central banks has been to engage in monetary policy in order to deliver stable prices, stable growth and stable currencies. However, central banks have thoroughly failed in this, as the frequency and amplitude of business cycles has increased during this time period, and more traditional cycles of growth and recession have been replaced by boom-bust cycles. …

Central banks are now in the process of consolidating their powers. They wish to get rid of competition in the form of paper money or bank credit. They are driving both cash and bank credit out of business through their negative interest rates [which reduce profits for private banks. They aim to become] … the complete masters of our lives, by allowing only digital currency that they issue and control — and that they can monitor in terms of all transactions, and that they can switch off, if, for instance, some pesky dissident criticizes them too much.

On this road to Orwellian totalitarianism by the central planners at the central banks, it is only a small further step to argue that the little chips on our digital cash cards would be safer — in the name of combatting crime again! — if one embedded them under the skin of our right hands, or our foreheads. …

The overarching trend of the 20th century has been the concentration of power in the hands of the few. This has not been a healthy trend, as many millions of innocent people died during the 20th century.

Central banks have been key beneficiaries and today’s locus of this unprecedented concentration of power. At the same time, central banks lack accountability. …

Lord Acton, a shrewd observer of power, concluded: “Power tends to corrupt and absolute power corrupts absolutely.”

Lesser known is that he also seems to have been aware of the power in the hands of the bankers: “The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.” …

The truth of the matter is: We don’t need central banks. Since 97% of the money supply is created by banks, the importance of central banks is far smaller than generally envisaged.

If you are interested in the power money has in society, this is an important article.