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Adair Turner: The Clearest Explanation of the Cause of Financial Crisis

 

Adair Turner, the chairman of the UK’s Financial Services Authority, member of the BoE’s Financial Policy Committee,  set out the fundamental cause of the financial crisis in his speech to the South African Reserve Bank on Friday 2nd Nov 2012:

“The financial crisis of 2007/08 occurred because we failed to constrain the private financial system’s creation of private credit and money.”

This is something what we’ve been saying for over two years: that if we allow banks to create money effectively out of nothing, in the way that we’re doing at the moment, then sooner or later we’re going to end up with a financial crisis, debt crisis and the situation that we find ourselves in today.

But this, coming from a chairman of FSA, is the clearest explanation of what is going wrong with our current economic system that has ever come from one of the people who are in charge of regulating the system.

“…the existence of banks as we know them today – fractional reserve banks – exacerbates these risks because banks can create credit and private money, and unless controlled, will tend to create sub-optimally large or sub-optimally unstable quantities of both credit and private money.

Lord Turner further describes the negative impacts of fractional reserve banking:

The impact of fractional reserve banks is thus to make the financial system and the overall economy inherently more vulnerable to instability, creating risks which have to be balanced against the economic advantages which can arise from the risk pooling and maturity transformation which banks perform.”

Banks which can create credit and money to finance asset price booms are thus inherently dangerous institutions.

He then gives a clear description of what banks actually really do:
The banking system can thus create credit and create spending power  – a reality not well captured by many apparently common sense descriptions of the functions which banks perform.  Banks it is often said take deposits from savers (for instance households) and lend it to borrowers (for instance businesses).  But in fact they don’t just allocate pre-existing savings; collectively they create both credit and the deposit money which appears to finance that credit.
Thus banks can create credit and private money.  

He also references to the work of Prof Richard Werner, who is a member of Positive Money’s Board of Advisors, and with whom Positive Money has made a joint submission to the Independent Commission on Banking that recommended the implementation of full-reserve banking for the UK.

“Werner is one among few modern economists who have focused on describing and thinking through the implications of the fundamentals of bank money creation, in the same fashion as did earlier economists such as Irving Fisher or Henry Simons.”

Adair Turner then goes on to look into the early Full Reserve Banking proposals (Chicago Plan):

The answer the early Chicago’s theorists gave us was ‘very radical’– so radical indeed as effectively to abolish leveraged maturity transforming, fractional reserve banks.

Thus in the Chicago Plan and other variants of 100% money banks (Exhibit 24) no private money is created since no private credit is extended, but instead all money in circulation derives from public debt or money issuance.

Essentially this would mean that banks which provided money services would face a 100% liquid assets requirement: while any institutions which made loans would face a 100% capital requirement, and could hold no deposits a set of prudential requirements which certainly makes Basel 3 look a pretty weak package.

He also comments on the recent IMF working paper “Chicago Plan Revisited”:

But extreme though it is, there are modern economists who believe that the Chicago Plan is a feasible model for real world policy. Indeed in an IMF working paper published in august this year, entitled ‘The Chicago Plan Revisited’ Jaromir Benes and Michael Kumhof have argued that a transition to a 100% money banking system is both desirable and possible, and that it could and should be accompanied by a dramatic write-down of existing household debts, removing in one fell swoop the vulnerability to financial and macroeconomic instability created by high levels of household leverage.

Although Adair Turner is not convinced that we could or should move away from fractional reserve banks, he thinks “we should take their ideas – rooted as they are in theoretical clarity about the origins of financial instability – as a spur to radicalism in our response to the financial crisis.”

 ”If we really have constructed an economic system in which adequate nominal demand growth is only attainable with a continual upward creep in the level of debt to GDP, we have created a dangerous system and should seek to identify less risky ways ensure that demand is adequate.”

Read the full speech here.

 

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  • DozyHole

    I thought I would miss Mervyn but if this is the next governor then things don’t look too bad for the future. We need open minds.

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  • David Jones

    Somewhat encouraging stuff, but…

    I suppose having a BOE governor who accepts some basic facts of reality (banks create money, banks create too much money and cause financial crises etc.) is better than having one who chooses conventional economic “wisdom” over said basic facts of reality. But having quickly read through his speech, I’m still left wondering what sorts of concrete policy measures Adair Turner actually has in mind (given full reserves are being rejected…) and am still skeptical of the idea that anything based on higher “capital adequacy ratios” or whatnot will actually work.

    Does Adair Turner accept the reality of an endogenous money supply, or does he still buy into the erroneous “money multiplier” stuff you’ll find in undergraduate economics textbooks? His goldsmiths example in this speech would seem to suggest the latter. I’d like to see somebody actually pin him down on this…

    Also – and this is hardly a trivial point – I am skeptical of the idea that maintaining “adequate nominal demand growth” and maintaining a habitable planet for future generations are in fact compatible goals. Is it too much to ask to have a potential BOE governor (and current Chairman of the Committee on Climate Change no less!) willing to question the dogma of perpetual economic growth on a finite planet? Plus if peak oil theorists like Richard Heinberg are right then the age of growth is essentially over anyway and it would be prudent to start preparing for a contracting economy – a good starting point here would be to design a financial system that doesn’t crash your economy the second it stops growing!

  • Simon

    He is about half way to Damascus…

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  • http://www.facebook.com/Stephannie.Roxanne.Clifton Stephanie Clifton

    I’m pleased he knows about it.

    According to this link:

    https://www.youtube.com/watch?feature=player_embedded&v=lrQX4CF6Bxs

    So
    …If you can raise £50 million pounds (what is needed
    to start a bank) then really you’ve raised infinity of money, because
    you have the power to just create imaginary money at the expense of your
    countries value.
    The
    government is so dumb to hand this power over to anybody, after all a
    bank could literally strip the value from the country, just like a
    takeover company asset stripping. Realistically, this could be the new
    warfare and Conquering of countries in the
    modern day. Think how many foreign banks there are
    in this country, they could just go mad and offer mortgages galore
    knowing they are devaluing a country. Who knows, some genius could have
    had this plan 10 years ago and is working towards the downfall of
    westernised countries, in order to bring the rising of the struggling
    nations and change the power of the world? Just a thought.

    We also need a government that runs it’s country like a business, competing and trading with the other countries, The Uk government does not seem to get to grips with the long term problems, maybe that because they only get a small window of power, but there should be better advisories for all parties.

    43 minutes ago · Like

  • http://www.facebook.com/Stephannie.Roxanne.Clifton Stephanie Clifton

    I’ve had an idea to solve immgration problems and maybe economical. Citizens of a country should be seen as “Bonds”.

    If one Citizen emigrates to another country for asylum for instance,
    that person sacrifices his/her Bond to the country the come from the the
    country they are going to. Ie Isreal to Australia.
    If Australia holds a greatest share of bonds, then they have conquered that country an
    d will hold power and ruling to it.
    This would step up the game and make sure governments looked after its Citizens.

    It would also encourage the Governments to make their countries more
    appealable to attract immgration. It will also elimate the fear of not
    being able to support its Citizens as the countries would inherit the
    wealth of the other countries too.
    Then the best government will be elected by footfall and would have the right power over the world.

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  • http://www.facebook.com/profile.php?id=100001572308913 Ashley Smith

    Breathtaking and hypocritical at the same time. Saying what we have all known about for 20 years and still doing nothing about it. I am left speechless than any regulator still has a job. If the rest of us were as negligent at our won work we would be fired.

  • http://www.facebook.com/profile.php?id=100001572308913 Ashley Smith

    Breathtaking and hypocritical at the same time. Saying what we have all known about for 20 years and still doing nothing about it. I am left speechless than any regulator still has a job. If the rest of us were as negligent at our won work we would be fired.

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  • http://www.facebook.com/profile.php?id=100000181074589 Anthony Migchels

    The Problem is not Debt, it’s Interest.

    Money creation is just fine, but it’s done by a monopoly parading as ‘competing’ banks (who all own each other and are in fact one massive cartel).

    we want interest free credit, not fully backed usurious credit. Under a full reserve banking system we would still be paying 300,000 pounds interest over a 200,000 pound mortgage over 30 years.

    All the money is and can be created through credit, which is grand. We just don’t want to be enslaved by the interest on it.

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