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Corporatism, over-regulation and fully reserved banking

The last post I wrote on endogenous money and fully reserved banking set out a case for viewing the demand for credit to attain real or financial assets as a fundamental aspect of any monetary system. The point of that post was to make clear that the real economy comes first and that money is merely a tool to effect financial transactions in the real economy. The cause and effect of credit flows from this demand for real resources as cause to the increase of money or credit in the financial system as effect. One point I failed to mention was regulation and the role of government in setting the up the rules of the game.

I am in favour of a liberal, free market system of capitalism in which regulation is limited to setting the ground rules that let private enterprise flourish. As I recently wrote in the context of the Fed’s attempts to create wealth via quantitative easing, “the private sector composed of individuals and businesses creates wealth. Government facilitates wealth creation by setting up an economic infrastructure that leads to improvements in the long-term social and economic outcomes that an individual economy most values.” I see regulation as simply facilitating this process and nothing more.

The reality, however, is that governments are now fully in the thrall of corporate interests. I am not just talking about the infamous military-industrial complex of which US President Dwight Eisenhower warned just over 50 years ago. I mean to say that the playing field is fully tilted toward big business through and through. That’s why we got the Citizens United Verdict. That’s why corporate profits are near record levels despite the fact that we are going through the most severe economic crisis since the Great Depression. And that’s also why the last election cycle in the United States was the most expensive in history, driven as it was by corporate interests.

The Corporatist of today is clever in cloaking his rent-seeking in the mantel of free market ideology by asking government to take a hands-off approach so that he can have a free hand in bending the market to his will. This corrupt and cynical relationship between big government and big business is what I have called Corporatism masquerading as liberty. And the banking industry is foremost in playing this game. Money manager and blogger Cullen Roche was right when he wrote earlier today that “[e]ven our govt borrows from this banking oligopoly. Why do people think the govt is in control? The banks rule the monetary roost.”

It is interesting that well into the last global debt deflationary episode, US President Roosevelt in 1940 was forced to renounce claim to his party’s Presidential nomination until the party brought the corporatists to heel. His stinging rebuke of his party’s corporatism was largely unknown until Oliver Stone publicized it in a recent television documentary on the Untold History of the United States.

Roosevelt wrote***: 

July 18, 1940

Members of the Convention:

In the century in which we live, the Democratic Party has received the support of the electorate only when the party, with absolute clarity, has been the champion of progressive and liberal policies and principles of government.

The party has failed consistently when through political trading and chicanery it has fallen into the control of those interests, personal and financial, which think in terms of dollars instead of in terms of human values.

The Republican Party has made its nominations this year at the dictation of those who, we all know, always place money ahead of human progress.

The Democratic Convention, as appears clear from the events of today, is divided on this fundamental issue. Until the Democratic Party through this convention makes overwhelmingly clear its stand in favor of social progress and liberalism, and shakes off all the shackles of control fastened upon it by the forces of conservatism, reaction, and appeasement, it will not continue its march of victory.

It is without question that certain political influences pledged to reaction in domestic affairs and to appeasement in foreign affairs have been busily engaged behind the scenes in the promotion of discord since this Convention convened.

Under these circumstances, I cannot, in all honor, and will not, merely for political expediency, go along with the cheap bargaining and political maneuvering which have brought about party dissension in this convention.

It is best not to straddle ideals.

In these days of danger when democracy must be more than vigilant, there can be no connivance with the kind of politics which has internally weakened nations abroad before the enemy has struck from without.

It is best for America to have the fight out here and now.

I wish to give the Democratic Party the opportunity to make its historic decision clearly and without equivocation. The party must go wholly one way or wholly the other. It cannot face in both directions at the same time.

By declining the honor of the nomination for the presidency, I can restore that opportunity to the convention. I so do.

No such appeals to “human values” over “dollar” values and Corporatism are going to be forthcoming in today’s political environment.

The right approach to regulation would be to set up a regulatory framework that leads to the improvements in long-term social and economic outcomes we desire but that also prevents market failure and is redundant enough to deal with market failure, should it come to that. And when you set up that framework, you have to enforce the rules or the result is catastrophe. We are doing none of this in the financial sector; it is just the opposite because of vested corporate interests. That’s what too big to fail is all about.

I find it interesting in this context that free market proponents would take the opposite tack of the Corporatist and promote an over-regulation of the banking sector via fully reserved banking in order to defend the free markets. This is what fully-reserved banking is: over-regulation. The calls for fully reserved banking have the same impetus as the calls for increased bank capital requirements. The thinking in both cases is that by increasing the regulatory hurdles for the banking system – by making the ground rules of financial services regulation tougher – we can safeguard the financial system and decrease systemic crises. I can see the benefits of increased capital given how the endogeny of money and credit creates capital constraints at the nadir of every business cycle. But on fully reserved banking reserve requirements, I fail to see the point. Here’s the thing: of the banking systems that have eliminated reserve requirements, only the United Kingdom was integrally involved in the last financial crisis. Canada, New Zealand, Mexico, and Australia were less affected than most. In Sweden, where no reserve requirement exists, the banking system’s connection to the Baltics made the impact very real, but even here, the banking system has recovered well.

My point? Fully reserved banking is not only ineffective at limiting credit growth because money is endogenous, it is also a form of heavy regulation that is unnecessary to safeguard a financial system against systemic crisis. The question I ask myself then is why are true free market proponents advocating this kind of regulatory intervention when it is antithetical to their ideological leanings of free markets and less regulation? Personally, I don’t have a clue. If someone has the answer why heavy regulation via fully reserved banking is necessary to successfully maintain a free market economy’s banking system, I’d love to hear it.

For now though, this is just an idle question because fully reserved banking has zero chance of happening in any advanced financial system because transitioning to such a system would instantly create an economic depression as financial institutions rebalance portfolios to accommodate the rules on holding only liquid assets. But I thought I’d put this out there because no one seems to be asking it.

**UPDATE 16 Nov 2012: Note that Roosevelt penned the anti-Corporatist letter above but never sent it because he was able to get his party to sanction his choice for running mate.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

8 Comments

  1. FalkBurger says:

    Very informative and useful. One question: your explanation of endogenous money does not account for the current unavailability of credit, even as demand is strong.

    • It does because the demand for credit by CREDIWORTHY borrowers is what is key. As I wrote in the first post here:

      http://www.creditwritedowns.com/2012/11/endogenous-money-and-fully-reserved-banking.html

      “Clearly, uncreditworthy borrowers – or the borrowers that financial institutions fear are uncreditworthy – have an infinite demand for credit because that credit can supply them with a limitless capacity for current consumption. However, banks remain solvent by supplying credit only to those entities which can repay their IOUs or by selling the IOUs on to less discriminating creditors. “

  2. FalkBurger says:

    Thanks again, Edward, but still there remains a large body of creditworthy borrowers going unserviced by banks, and we see Wal-Mart and other players getting into the game to satisfy the demand unmet by banks. What is keeping the banks from doing their part?

    • Credit conditions are still tight- especially on mortgages – although they are loosening, particularly on auto loans. Clearly the banks don’t believe these customers are creditworthy irrespective of what Walmart does. Capital constraints are less the issue now.

      • David_Lazarus says:

        I still think banks fear big losses on real estate. While many think that US real estate has bottomed I think there could be big losses still to come. There are still lots of second mortgages and these will be substantially underwater if credit conditions do not improve. I fear another 20% more losses to come.

  3. Joe says:

    The mantra that big government is bad all the time no longer resonates like it used to in a world rocked by a financial crisis by big banks. People still distrust big government, but there equally as distrustful of big corporate. This explains why approval ratings for both big corporate and big government are at crisis low levels. The Nixon/Carter/Reagan eras destroyed our trust in government, and the financial crisis destroyed our trust in big corporate.

    This is a key reason why Romney was not an obvious choice vs. Obama, even in an election in an anemic economy.

    Like you, I would define good government as small government that sets ground rules (regulations), and has enough resources to police and punish the egregious offenders. The devil is in the details here, and it’s challenging to do right. Too much regulation is a bad thing, but so is too little. The answer is no longer as simple as deregulate, deregulate, deregulate.

    And this has profound political and economic consequences that many politicians and economists continue to respond to with head in the sand syndrome. Steve Hanke, for example, on Econtalk, talked about the need to just do away with the Basel III
    regulations because regulation slows down the credit accelerator and broad money
    supply. Maybe Basel III needs to be replaced with some other form of regulation, but that was not Steve’s recommendation – I took away from the podcast that we just need to broom Basel III away with no alternative to that. Yes, regulating credit will slow down credit creation, but the right amount of regulation will also lead to more stable economic growth. Executing regulation well is challenging, but the completely hands off stance so frequently advocated leads to debt deflation and Depression.

    I read this blog because you look at these issues squarely in the face.