Banking – a risky business now and in medieval times

Modern bankers are protected from personal bankruptcy by the concept of “too big to fail.”   This hasn’t always been the case as in medieval times banking was a very risky business with failed bankers losing everything.

I have just finished reading Money, banking and credit in Medieval Bruges by Raymond de Roover who discusses a number of issues about money and banking most of which are still relevant.

His book covers the Italian merchant bankers who used bills of exchange to avoid shipping specie, the Lombards who operated as pawnbrokers to provide licensed usury and retail credit and the money changers who were the forerunners of today’s commercial banks.  It is the latter that I found most interesting.

One of the first things to impress me was de Roover’s use of the term purchasing power to describe money.    When so many people think of money as a commodity with a value in its own right, it is important to be reminded that the main function of money is as purchasing power.  He points out the Italian merchant bankers used bills of exchange to transfer purchasing power from one place to another.  Also the money changers transferred purchasing power when they assisted their customers to transfer funds from one person to another.

Briefcase_Vector_DesignMedieval bankers knew that loans to princes and governments were perilous and should be avoided.  Considering the amount of debt owed by governments today is so great it will never  be repaid this is probably a good rule.  Rolling over debt plus interest is a racket and a lot of people are going to lose a lot of purchasing power.   Some will find their retirement plans disappearing.

De Roover is emphatic that the money changers were creating money through their fractional reserve policies.  They were accepting deposits and making transfers of purchasing power by via entries from one account to another.  As all the money changers were physically close they could do transfers between customers of different bankers.  As most of their transfers were on paper and they kept about 30 per cent in reserve,  much of the money in their strong boxes was available for other uses.  Some was loaned to customers as overdrafts and the rest was invested in commercial ventures.  In either case they were creating fractional reserve money and adding to the money supply.  Modern banks follow a fractional reserve policy and are creating money when they make loans.

Because of usury laws no interest was paid on deposits or charged on overdrafts.  They made their money on exchanging currency and from investments.  This is interesting because I believe interest being charged on fractional reserve money/loans causes us a lot of problems.

By making investments in commercial ventures the money changers were living dangerously because this money was not on hand if requested by depositors.  Financing long-term investments with short-term or demand deposits is a high risk business plan and many money-changers found themselves bankrupt.  De Roover quotes a medieval source as saying that in Venice 96 out of 103 banks came to a bad end.  He figures this may be an exaggeration but in any case banking was a high risk venture and many bankers lost everything.

When we had our banking crisis a few years ago some bankers were financing sub prime mortgages with overnight loans.   This was more dangerous than the medieval money changers because it was on a much larger scale.  This practice was highly profitable because of the high spreads between short- and long-term interest rates.     When it became apparent these mortgages were problems the overnight financing was no longer available and the banks were in serious difficulty.

The difference between the money changers and Wall Street bankers was that the money changers were very small operations.  The concept of too big to fail had not yet been invented.  Even so the payment transfer function was so important that new money changers quickly appeared and eventually a number of medieval cities established civic banks to perform that function.

There are a number of issues discussed in this book many of them still problems even if on a much larger scale.

I have long believed that banking is a risky business and that there is a need to find a way of creating money other than the fractional reserves of banking.  I still do.


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The morality of austerity and inflation

Somebody on LinkedIn has asked if austerity is a morality issue.

Of  course austerity is a morality issue but so is inflation.

Austerity is a moral issue because it inflicts unemployment and hardship on some people.  Inflation is a moral issue because it is a form of theft in that it reduces  the purchasing power of savings and pensions.  The opposite to austerity is government stimulus spending but it is not clear we can have stimulus without inflation.

So the challenge is to design a way of exchanging goods and services and a money system to facilitate that exchange such that there is no inflation or deflation.  To do this we will have to first challenge all sorts of motherhood issues with regard to money, work and economics.


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The seeds and the bees

The headline on this article in a Canadian farm newspaper looks like a technical matter involving corn yields and coating seeds with a pesticide.  However when one takes a closer look one finds that some people claim this pesticide is killing bees.  That may not be just a technical matter.

queenbeeAgricultural issues are too important to be left to people whose income depends upon maximizing production.

The Western Producer, a weekly newspaper for farmers in Western Canada has recently published a number of articles on the use of neonicotinoids on seeds.

The underground economy

The underground economy is fascinating because it involves civil disobedience, desperation or criminal behaviour.

My understanding of the underground economy is that it is economic activity that contradicts some legislation and is thus illegal.  By this definition, people who live on the economic margins may not be participating in the underground economy as most of what they do is not illegal.  How can you break the tax laws if your income is not enough to be taxable?

trapdoorCivil disobedience is a complex subject with lots of moral issues and variations. (Are there other ways of protesting a law?)   I think of it as deliberately disobeying a law because one disagrees with that law.  As most economic legislation works to limit competition so that a few people can make profits they otherwise would not get, there are a lot of unjust economic laws and many opportunities for civil disobedience.  Examples include subsidies, trade restrictions,licensing, copyright and patents.  Legislation that imposes morals, religious values or sexuality upon people who don’t share those values also invites civil disobedience.

Economic civil disobedience  might be more effective if it were organized and stated to be civil disobedience.

Generally people living on welfare are living very close to the subsistence margin.   As the welfare rules tend to be restrictive  the only way these desperate people can get anything extra is to break the rules and/or not declare any extra income they can scrap up.  I think a lot of these people are there through no fault of their own.  They deserve a lot of sympathy and more generous welfare rates.  I believe we should have a collective responsibility to ensure everyone has the opportunity to live the same standard of living as most other people.  Illegal immigrants are also probably here out of desperation or because they are better off here illegally than they were in their home countries.

There is also a double standard in hitting welfare recipients  in that wealthy people are good at ensuring tax legislation has lots of loopholes from which they can benefit.

A third type of underground economic activity is exploitive and/or deliberately criminal.  I am thinking of people who employ illegal immigrants and get away with inhumane working conditions because their employees are afraid of deportation.  We cannot tolerate inhumane working conditions in Canada or the United States although Bangladesh is somehow different.

This post was inspired by a post on a weblog by Eric Hare titled “Cheers for the Underground Economy!”  I wish there were no need for an underground economy although when we hire neighbors to do some little job for us I usually pay in cash.


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Economic growth and thinking outside the box

This column in The Economist leaves me feeling extremely uncomfortable because it speaks for all those economists (and others) who are in denial about the reasons  for the economic crisis and the need for thinking outside the conventional economic box to deal with it.

For some time The Economist has been saying the economic crisis must and can only be solved with more growth.  And the way to attain economic growth is innovation and increasing productivity.  This column claims aging workers become less productive than younger workers and the aging workforce dooms us to decreasing rather than increasing productivity.

clownIf only older workers could increase their productivity then all our problems would be solved.

Another article in the same issue talks about the economic crisis around the world.  I find it a bit of a stretch to think that all these problems are a result of an aging workforce in the rich world countries.

One has to observe that in the last few years the marginal cost of a lot of energy and mineral resources has gone up.  This means the most easily extracted of these resources have now been used.  What is left will require more energy to extract.  This has to have a negative impact on our economy.   It could even mean that future growth will be difficult if not impossible.

This is a much more serious issue than what most people can admit.  Rather than asking people to work harder and to use  Google glasses we need to look for ways to organize our economy so that our welfare does not depend upon continued economic growth.


If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

Bitcoins, gold and pyrite

Bitcoins and gold may have some speculative value but as a solution to economic problems or as a form of money they are on a par with pyrite

As I understand bitcoins their main feature is that the supply of them is intended to be finite.  This will make them great for speculators but as a form of money they come with the same problem as gold and that is that the amount of money in an economy needs to be flexible.  Through history there have been a number of situations where authorities have tried to limit the money, sometimes by trying to force a gold standard, and the result has been serious depression.  I wonder if bitcoins were invented in part because gold is in limited supply.

circleBitcoinProbably the increasing interest in  bitcoins is a psychological reaction to economic uncertainty and fears of hyperinflation which would wipe out the savings and pensions of a lot of people.  Given that the economic crisis is based on problems in the resource base gold and bitcoins may not be useful.  A better hedge would be a market garden.

Another feature of bitcoins is that they can be used online anonymously .  This makes them great for illegal transactions.   No wonder some regulators are saying bitcoins should come under their jurisdiction.

So far as I can see the main use of bitcoins is for speculation.

Fossil fuel reserves

An article in this week’s The Economist talks about reserves of fossil fuels and points out existing reserves exceed what can be burned if governments stick to plans for controlling climate change.  It seems many people in the business don’t expect governments to hold the line.

regelatwork_Oil_rigAnother factor which may limit the value of these deposits is the marginal cost of extracting them. As we extract the most easily accessible of resources the cost of extracting the remaining resources increases.  Perhaps we should calculate the costs in terms of energy.  How many units of energy does it take to extract 100 units of energy?  As this figure goes up it is going to reduce the energy available for other economic activity and is certain the have a negative influence on economic growth.

Those who have a religious-like faith in economics will say innovation and technology will save the day and we are bound to return to economic growth.  They could be right, or partially right, but it might be wise be a little skeptical.

The costs of extracting fossil fuel reserves should be considered in determining their value and evaluating their potential contribution to the economy

There are still lots of energy resources in the crust of this planet and the energy companies will probably identify more of them.  What isn’t so clear is that these resources will be available either because of government policy on climate change or the economics of extracting them.

Subsidies for consumers rather than producers

People writing for and editing a magazine named The Economist should know that government subsidies to manufacturers are evil in that they distort prices, cause inefficiencies in production and are unfair in that they help a few people and not others.  Yet in this article this magazine appears to be saying subsidies are to be encouraged.

Governments give out subsidies to protect jobs or to encourage firms to locate and provide jobs in their areas.

Surely it would be better to give subsidies to consumers rather than producers.  Then prices would not be distorted and the market economy would operate efficiently and according to the values of all people.

Also subsidies to consumers rather than producers could be organized so that we could meet a collective responsibility to ensure all people have the opportunity for minimum standard of living.

Tragic food and clothes

For most us in the richer countries eating and clothing ourselves is done at the expense of the environment or by exploiting cheap labor in or from the poorer countries.  This happens because the world’s supply of labor exceeds the demand.

A tragedy in Bangladesh probably will not change anything.

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