Savings banking system and its implications (and II) In the previous entry , simply tried to explain the role of banks, central banks, along with a brief reference to monetary policy. In this article we will discuss my views on the fractional reserve system that regulates the current financial system and its implications on the economy. Remember
previously that a fractional reserve system means that banks are only obliged to keep reserves to 2% of money deposited on demand by its customers, while 98% can be arranged freely. The origin of this mechanism is found in the Peel Act of 1844 (
Peels Bank Act), adopted by the then UK Prime Minister Robert Peel
, which is established as compulsory reserve ratio of 100 % in gold to private banks regarding the issuance of paper money (gold standard
), But making the big mistake of forgetting to apply the same policy on deposits. This enabled the development and extension of fractional reserve banking and credit expansion. However, it also allowed the creation of one of the biggest problems in the current banking system: central banks. In the words of Professor Jesus Huerta del Soto
"Peel Act of 1884 [...], supported the creation of a central banking system, then, especially because of the negative influence of theorists Banking School
as Marshall and Keynes
ended up being used as a backup from erroneous theories of these prestigious economists, to justify and promote a policy of uncontrolled monetary and financial outrage far worse than those they originally intended to remedy. "(HUERTA DEL SOTO, J. 1994, 133).
The creation of this such entities is to go against the natural evolution of the banking system and allows to unleash "an illegitimate act of misappropriation" (HUERTA DEL SOTO, J. 1994, 133). Since the deposit is a custody, legal contracts which is "the obligation to have it available to the depositor an amount equal to that received ..." (Garrigues, J. 1975, 365) as they act as responsible ultimately from the mismanagement of irresponsible bankers. As the teacher tells the Soto Huerta: "This was, at first, in a shameful and secret, it was still part of the bankers the consciousness of a wrongdoing, and then only the bankers get to the violation of traditional principle of law is carried out in an open and legal, when the government happily get
privilege to use their own benefit the money from their depositors (usually in the form of loans are often granted, at first , the government itself). Thus begins the relationship of complicity and the coalition of interest that has become a tradition that exists between governments and banks, and that explains perfectly compression intimate relations and cooperation between both institutions and be seen today [...]. And the bankers soon realized that the violation of the traditional principle of the right mentioned resulted in a highly lucrative financial activity ... "(HUERTA DEL SOTO, J. 1994, 136-137)
The pernicious role of central banks are better understood when it explains also his culpability in the economic cycles of boom and bust since its creation, the system has been suffering. Recall that the fractional reserve system allows for expansion credit and also their own central banks control monetary policy, mainly through adjustments in the interest rate. Take a real example.
In 2001, the bombing of the twin towers causing an economic downturn affecting just the dot-com. To prevent a fall in consumption, because when the consumer sees hard times ahead increasing their savings, the central bank decides to lower interest rates so: a) not as attractive savings, due to the low remuneration of interest we offer; b) increases the money supply in circulation, because the banks can be funded much more cheaply in the markets inter-bank.
These measures seek to maintain or increase private consumption, not to jeopardize the production and therefore economic growth. But adulterated form, of course.
banks customers find that really does not come as a saving account and to invest their savings in other assets or property is more lucrative than the 1% offered by your bank, so just removing all or part of their savings. Banks seen as reducing one of its lines of business (the person in the industry jargon) and must find another way to grow through loans (by assets). Because they have money to lend out very cheap because interest rates central bank are very low, can provide loans and credits to its customers at rates attractive to invest their savings in more profitable. This mechanism is enhanced by the fractional reserve system, since banks are not interested in having lots of money in the coffers of the central bank, which also offers a very low rate, thus maintaining the minimum legal reserve ratio required, 2%.
This causes a real binge of easy money to invest and develop projects. The equation that savings equals investment is not so clear, it is clear that the money has increased but not by real savings, but because the fractional reserve mechanism.
that funding is no real savings, which distorts the signal for investors, entrepreneurs and individuals. Something that explains perfectly the
Austrian Business Cycle Theory . Summary exposed and brilliantly, of course, by Professor Huerta del Soto, is a long excerpt, but I assure you it is worth:
"And is that exchange rates are never neutral. When you create a certain amount new money, it always enters the economy for a very specific point, is spent first on certain goods and services and only then, slowly, its effects are spreading through the rest of the structure productive. This implies that some prices will be affected before others, modifying the allocation of resources as a result. In fact, thanks to the arrival of new money, some employers who have obtained losses, profit, and many workers who would not have found jobs in certain sectors, they are easily employed therein; also created new types of business , expanding existing facilities.
Generally, the new money comes to the market after artificially reducing interest rates, within a clear policy of credit expansion. The lower the discount rate and the best facilities credit, of course, increase capital expenditure in relation to consumption expenditures, distorting all the indicators that guide entrepreneurs, especially the return on capital invested in each of the stages or phases in which, for the Austrians is divided the structure of production. These stages represent successive interrelated production processes, from goods of higher order than those closest to consumption, there in reality they are combined in the most heterogeneous capital goods are produced with the original factors (land and labor), to give rise to more sophisticated capital goods, and ultimately instance, after the necessary waiting to consumer goods.
What is clear is that, as a result of low interest rates now appear to be beneficial investments that were not before. That the relative increase in investment spending increases the price of production factors, which tend to adopt less intensive production methods in working with a notable increase in demand for many natural resources. Simultaneously, reduced profits in consumer goods industries (who see their costs increase but the same will happen with prices), starting a transfer of productive factors of the same to the capital goods industries. Such transfer should continue for a fairly long period of time, if you want to end some day, with the new structure more capitalist production has just begun (it should be noted that a machine whose value depends on the occurrence of other capital goods that are necessary for use becomes useless if a lack of resources they fail to occur).
But soon the demand for consumer goods begins to increase as a result of increased income earned by the factors of production (motivated in turn by the money pumped into the system and which is now coming to them) . Consumers need not have changed significantly from the proportion that the first distributed their income between present and future assets, becoming evident a general rise in prices of consumer goods based upon: a) the natural effect of the arrival of new money supply to the sector, whose demand for it is increased and b) the fact that the flow in the supply of consumer goods, of course, must decrease for a while, once you start the lengthening of production processes, and as they complete the new capitalist structure, not only because withdraw resources from areas closer to the consumer, but also because it devotes a large part of the same investments that only much later start to produce results.
Rising prices, and created in the sector of consumer goods, produce completely opposite effects to those described for credit expansion: the benefits of closer consumer industries begin to rise, while the corresponding decay the investment goods sectors. Capital goods production began in mind a very capitalist production structure must adapt, if possible, to one that is less (and thus is more labor-intensive, of course, if one that the rise in consumer prices is a reduction in real wages). And in general, the transfer begins productive factors of investment to consumption, to appreciate great losses in the most capitalist (construction, shipbuilding, etc.), which are only profitable for low interest rates, and is now heavily developed. In sum, economic depression has come for lack of resources to complete some changes in the structure of production too ambitious, depression manifested externally by the existence of excess production in the sectors of investment and a shortage of it in the most future consumption. "(HUERTA DEL SOTO, J. 1994, 165-1667).
Does that sound of something all the lines described above?
BIBLIOGRAPHY:
HUERTA DEL SOTO, JESUS \u200b\u200b(1994): New studies
Political Economy. Second Edition. New Library of Liberty. Editorial Union. Madrid.
Joaquín Garrigues (1975): Contracts
bank. Second Edition. Madrid.
