The Transformation of Banking
There is a scene in the Parable of the Talents in which the returned master berates the shabbiest of his three servants. Discovering that he had buried his seed capital in the ground, the master says: “You should have put my money on deposit with the bankers, so that when I returned I would have received it back with interest.” The servant is then thrown outside “into the darkness,” where he faces “weeping and gnashing of teeth.”
In today’s world, burying that money might have been the better idea. Otherwise, the servant would have paid fees for depositing, withdrawing and transferring and would have earned no interest at all, and the money would have depreciated in value the whole while. It’s enough to cause you to weep and gnash your teeth.
That parable has had a long life because earning interest on deposits is a universal feature of the human experience in any finance economy. Until now. The Fed has announced that it will work to keep interest rates at zero for the next several years, all with the supposed goal of refurbishing the economy. Or so Bernanke tells us at great length.
But here’s the problem: This very strategy of driving interest rates to zero has been a feature of the period in which the Fed has managed the post-meltdown world. The result has been what The Wall Street Journal accurately described as a five years of missing economic progress: The economy today is barely larger than it was at the end of 2007, despite a rising population and a gigantic explosion in technology. Household income is still sinking, and an entire generation has readjusted its expectations for the future.
What has the Fed done? It has moved to create and guarantee some $13 trillion in phony assets to prettify the balance sheets of financial institutions that would have otherwise gone belly up. Those fake assets have served as substitutes for real reserves to create the illusion of balanced books. It has made its own discount rate vanish as a way of opening up its own reserves to the banking system to keep it floating. Finally, it has made it clear that it stands ready to be the lender of last resort for just about everything, removing the risk premium that would normally be attached to longer-term loans.
Altogether, this strategy has nearly abolished the banking system’s capacity to function, in effect turning banks into public utilities to serve themselves and governments, instead of depositors and lenders. Private industry seeks funding outside the official banking system, investors are scrambling for some other option and banks themselves have turned to other pursuits, like interest rate arbitraging and lending to other financial institutions, hedge funds, insurance companies and real estate.
During the 1930s, New Deal policies tried to revive agriculture and economic activity generally by telling farmers to plough under their crops and kill their livestock. Today, Fed policies are trying to revive real estate, banking and economic activity generally by undermining the capacity of the loan markets to function with any degree of normalcy.
Michael Hudson insightfully explains the problem:
“People used to know what banks did. Bankers took deposits and lent them out, paying short-term depositors less than they charged for risky or less-liquid loans. The risk was borne by bankers, not depositors or the government…Banking has moved so far away from funding industrial growth and economic development that it now benefits primarily at the economy’s expense in a predatory and extractive way, not by making productive loans.”
Even if Bernanke were telling the truth that this is all about inspiring recovery, there is no hope that it can work. The real estate markets are still an amazing mess, with one-quarter of the existing mortgages contracts marked above their market value. It fights against gravity to keep trying to lift up what wants to go down the instant that artificial stimulus recedes. And it should be obvious by now that ever lower rates don’t stimulate lending in this environment, but rather the reverse.
As the Austrian tradition has long explained, the basis of future prosperity is capital accumulation and deferred consumption in the form of real savings. These policies punish both. Worse: They make conventional savings nearly impossible. These policies encourage ever more consumption and debt accumulation and do nothing to address the core problem that brought about the artificial boom and the resulting bust.
But is Bernanke really telling the truth? No. In the balance between restoring growth and saving the banking system from the consequences of its own irresponsible policies, the Fed has chosen the latter. This is the unavoidable conclusion.
Otherwise, we would have to believe that the Fed is utterly blind to the recently proven results of its own policies. It is not managing the Fed in the public interest, but in the interests of the banks and the governments that are in hock to them. That you can’t earn a reward from saving money anymore is a microeconomic indication of a much-larger problem.
Consider the opportunity costs of these policies. We are living in a time of unprecedented innovation, thanks to digital media, the Internet and daily improvements in the production, management and distribution of information. Vast swaths of the commodifiable world have left the realm of scarcity to enter the sector in which infinite reproducibility is not only possible, but a regular feature of daily life.
With a healthy economic foundation, society should be getting get wealthier and wealthier at a pace that exceeds even that of the Gilded Age, when 10% and 15% growth was common and the human population began to thrive as never before. The digital age has given us economizing technologies that make all that have come before look like mere warm-ups. Instead, we are being denied those benefits and that growth, thanks to catastrophic policies of governments backed by central banks and dependent financial institutions.
What is the scenario under which normalcy returns? From Bernanke’s point of view, there is no end to this. It means ongoing stagnation for no good reason. For this reason, there has never been a more urgent time to abolish the Fed, institute a free market system and let a new monetary system emerge on a sound foundation. At the same time, the Fed has never faced more reason to keep alive the system that is killing future prosperity.
If the Parable of the Talents could be retold today, it would need a different ending, with a different gang of thieves thrown into the darkness to face weeping and gnashing of teeth.