(Note : Part 1 of the debate is here, and there is a more general post about the lack of coverage of this historic debate here)
12.13 pmMr Peter Lilley (Hitchin and Harpenden) (Con): It is a pleasure, as always, to follow the right hon. Member for Oldham West and Royton (Mr Meacher), who gave us a characteristically thoughtful and radical speech. I do not necessarily start from the same premises as him, but what he says is an important contribution to the debate, on the securing of which I credit my hon. Friend the Member for Wycombe (Steve Baker). He has done the House and the country a service by forcing us to focus on the issue of where money comes from and what banks do. He did so in an insightful way.
Above all, he showed that he sees, as our old universities used to see, economics as a branch of moral sciences. It is not just a narrow, analytical, economic issue, but a moral, philosophical and ultimately a theological issue, which he illuminated well for the House.
A lot has been made of the ignorance of Members of Parliament of how money is created. I suspect that that ignorance, not just in Members of Parliament but in the intellectual elite in this country, explains many things, not least why we entered the financial crisis with a regulatory system that was so unprepared for a banking crisis. I suspect that it is because people have not reflected on why banks are so different from all other capitalist companies. They are different in three crucial respects, which is why they need a very different regulatory system from normal companies.
First, all bankers—not just rogue bankers but even the best, the most honourable and the most honest—do things that would land the rest of us in jail. Near my house in France is a large grain silo. After the harvest, farmers deposit grain in it. The silo gives them a certificate for every tonne of grain that they deposit. They can withdraw that amount of grain whenever they want by presenting that certificate. If the silo owner issued more certificates than there was grain kept in his silo, he would go to jail, but that is effectively what bankers do. They keep as reserves only a fraction of the money deposited with them, which is why we call the system the fractional reserve banking system. Murray Rothbard, a much neglected Austrian economist in this country, said very flatly that banking is therefore fraud: fractional reserve banking is fraud; it should be outlawed; banks should be required to keep 100% reserves against the money they lend out. I reject that conclusion, because there is a value in what banks do in transforming short-term savings into long-term investments. That is socially valuable and that is the function banks serve.
We should recognise the second distinctive feature of banks that arises directly from the fact that they have only a fraction of the reserves against the loans they make: banks, individually and collectively, are intrinsically unstable. They are unstable because they borrow short and lend long. I have been constantly amazed throughout the financial crisis to hear intelligent people say that the problem with Northern Rock, RBS or HBOS, or with the German, French, Greek and other banks that ran into problems, was the result of their borrowing short and lending long, and they should not have been doing it, as if it was a deviation from their normal role. Of course banks borrow short and lend long. That is what banks do. That is what they are there for. If they had not done that they would not be banks. Banking works so long as too many depositors do not try to withdraw their funds simultaneously. However, if depositors, retail or wholesale, withdraw or refuse to renew their short-term deposits, a bank will fail.
If normal companies fail, there is no need for the Government to intervene. Their assets will be redeployed in a more profitable use or taken over by a better-managed company. But if one bank fails, depositors are likely to withdraw deposits from other banks, about which there may also be doubts. A bank facing a run, whether or not initially justified, would be forced to call in loans or sell collateral, causing asset prices to fall, thereby undermining the solvency of other banks. So the failure of one bank may lead to the collapse of the whole banking system.
The third distinctive feature of banks was highlighted by my hon. Friend the Member for Wycombe: banks create money. The vast majority of money consists of bank deposits. If a bank lends a company £10 million, it does not need to go and borrow that money from a saver; it simply creates an extra £10 million by electronically crediting the company’s bank account with that sum. It creates £10 million out of thin air. By contrast, when a bank loan is repaid, that extinguishes money; it disappears into thin air. The total money supply increases when banks create new loans faster than old loans are repaid. That is where growth in the money supply usually comes from, and it is the normal situation in a growing economy. Ideally, credit should expand so that the supply of money grows sufficiently rapidly to finance growth in economic activity. When a bank or banks collapse, they will call in loans, which will reduce the money supply, which in turn will cause a contraction of activity throughout the economy.
In that respect, banks are totally different from other companies—even companies that also lend things. If a car rental company collapses, it does not lead to a reduction in the number of cars available in the economy. Its stock of cars can be sold off to other rental companies or to individuals. Nor does the collapse of one rental company weaken the position of other car rental companies; on the contrary, they then face less competition, which should strengthen their margins.
The collapse of a car rental company has no systemic implications, whereas the collapse of a bank can pull down the whole banking system and plunge the economy into recession. That is why we need a special regulatory regime for banks and, above all, a lender of last resort to pump in money if there is a run on the banks or a credit crunch, yet this was barely discussed when the new regulatory structure of our financial and banking system was set up in 1998. The focus then was on consumer protection issues. Systemic stability and the lender-of-last-resort function were scarcely mentioned. That is why the UK was so unprepared when the credit crunch struck in 2007. Nor were these aspects properly considered when the euro was set up. As a result, a currency and a banking system were established without the new central bank being given the power to act as lender of last resort. It has had to usurp that power, more or less illegally, but that is its own problem.
This analysis is not one of those insights that come from hindsight. Some while ago, Michael Howard, now the noble Lord Howard, reminded Parliament—and indeed me; I had completely forgotten—that I was shadow Chancellor when the Bill that became the Bank of England Act 1998 was introduced. He pointed out that I then warned the House that
This failure to focus on the fundamentals was not a peculiarly British thing. The EU made the same mistakes in spades when setting up the euro, and at the very apogee of the world financial system, they deluded themselves that instability was a thing of the past. In its “Global Financial Stability Report” of April 2006, less than 18 months before the crisis erupted, the International Monetary Fund, no less, said:
Bob Stewart (Beckenham) (Con): I am listening carefully to my right hon. Friend. Does that mean that the banks are uncontrollable, as things stand?
Mr Lilley: No; they can and should be controlled. They are controlled both by being required to have assets, and ultimately by the measures that Government should take to ensure that they do not expand lending too rapidly. That is the point that I want to come on to, because a failure to focus on the nature of banking and money creation causes confusion about the causes of inflation and the role of quantitative easing.
As too many people do not understand where money comes from, there is confusion about quantitative easing. To some extent, the monetarists, of whom I am one, are responsible for that confusion. For most of our lifetime, the basic economic problem has been inflation. There have been great debates about its causes. Ultimately, those debates were won by the monetarists. They said, “Inflation is caused by too much money—by money growing more rapidly than output. If that happens, inevitably and inexorably, prices will rise.” The trouble was that all too often, monetarists used the shorthand phrase, “Inflation is caused by Government printing too much money.” In fact, it is caused not by Government printing the money, but by banks lending money and then creating new money at too great a rate for the needs of the economy. We should have said, “Inflation follows when Governments allow or encourage banks to create money too rapidly.” The inflationary problem was not who created the money, but the fact that too much money was created.
The banks are now not lending enough to create enough money to finance the growth and expansion of the economy that we need. That is why the central bank steps in with quantitative easing, which is often described as the bank printing money. Those who have been brought up to believe that printing money was what caused inflation think that quantitative easing must, by definition, cause inflation. It only causes inflation if there is too much of it—if we create too much money at a faster rate than the growth of output, and therefore drive up prices—but that is not the situation at present.
Mr MacNeil: The right hon. Gentleman is giving a very good explanation of the different circumstances in which money is created. He has spoken about the morality, and about quantitative easing. When there is demand, what is his view of the theory of helicopter money, and where that money gets spread to?
Mr Lilley: As a disciple of Milton Friedman, I am rather attracted to the idea of helicopter money; I think it was he who introduced the metaphor, and said that it would be just as effective if money were sprayed by a helicopter as if it were created by banks. Hopefully, as I live quite near the helicopter route to Battersea, I would be a principal recipient. I do not think that there is a mechanism available that would allow us to do that, but I am not averse to that in principle, if someone could do it. My point is that the banks, either spontaneously or encouraged by the central bank through quantitative easing, must generate enough money to ensure that the economy can grow steadily and stably.
Mr MacNeil: Could it not be argued that increasing welfare payments would be a form of helicopter money, because the people most likely to spend money are those with very little money? If we put money in the pockets of those who have little money, it would be very positive, because of the economic multiplier; the money would be spent, and would circulate, very quickly.
Mr Lilley: There are far better reasons for giving money to poor people than because their money will circulate more rapidly—and there is no evidence for that; I invite the hon. Gentleman to read Milton Friedman’s “A Theory of the Consumption Function”, which showed that that is all nonsense. There are good reasons for giving money to poor people, namely that they are poor and need money. Whether the money should be injected by the Government spending more than they are raising, rather than by the central bank expanding its balance sheet, is a moot point.
All I want to argue today is that we should recognise that the economy is as much threatened by a shortage of money as it is by an excess of money. For most of our lifetimes the problem has been an excess, but now it is a shortage. We therefore need to balance in either occasion the rate of growth of money with the rate of growth of output if we are to have stability of prices and stable economic activity. I congratulate my hon. Friend the Member for Wycombe on bringing these important matters to the House’s attention.
12.30 pmAustin Mitchell (Great Grimsby) (Lab): I welcome this debate and congratulate hon. Friends on securing it, because we have not debated this matter for over 100 years, and it is time we did so. This House and the Government are obsessed with money and the economy, but we never debate the creation of money or credit, and we should, because, when it comes to our present economic situation and the way the banks and the economy are run, that is the elephant in the room. It is time to think not outside the box, but outside the banks; it is time to think about the creation of credit and money.
I speak as a renegade social creditor who is still influenced by social credit thinking; I do not pledge total allegiance to Major Douglas, but I am still influenced by him. As has just been pointed out, 93% of credit is created by the banks, and a characteristic of what has happened to the economy since the ’70s is the enormous expansion of that credit. I have here a graph from Positive Money showing that the money created by the banks was £109 billion in 1980. Thanks to the financial reforms and the huge increase in the power of the banks since then, by 2010 that figure had risen to £2,213 billion, whereas the total cash created by the Government—the other 3%—had barely increased at all. Since 2000 we have seen the amount of money created by the banks more than double.
That has transformed the economy, because it has financialised everything and made money far more important. It has created debt-fuelled growth followed by collapse. It is being controlled by the banks, which have directed the money into property and financial speculation. Only 8% of the credit created has been lent to new businesses. The Government talk about the march of the makers, but the makers are not marching into the banks, because the banks are turning them away. Even commercial property is more important than makers. That has created a very lop-sided economy, with a weak industrial base that cannot pay the nation’s way in the world because investment has been directed elsewhere, and a very unequal society, which has showered wealth on those at the top, as Piketty shows, and taken it away from those at the bottom.
A very undesirable situation is being created. We have built an unstable economy that is very exposed to risk and to bubble economics, thanks to the financialisation process that has gone on since 1979. The state allocates all credit creation to the banks and then has to bail them out and guarantee them, at enormous expense and with the creation of debt for the public, when the bubble bursts and they collapse.
Some argue—Major Douglas would have argued this—that credit should therefore be issued only by the state, through the Bank of England. That would probably be a step too far in the present situation, given our present lack of education, but we can and should create the credit issued by the banks. We can and should separate the banks’ utility function—servicing our needs, with cheque books, pay and so on—and their speculative role. The Americans have moved a step further, with the Volcker rule, but it is not quite strong enough. In this country we tend to rely on Chinese walls, which are not strong at all. I think that only a total separation of the banks’ utility and speculative arms will do it, because Chinese walls are infinitely penetrable and are regularly penetrated.
We can limit the credit creation by the banks by increasing the reserve ratios, which are comparatively low at the moment—the Government have been trying to edge them up, but not sufficiently—or we could limit their power to create credit to the amount of money deposited with the banks as a salutary control. We could tax them on the hidden benefit they get from creating credit, because they get the signorage on the credit they create. If credit is created by banknotes and cash issued by the Government, the Government get the profit on that—the signorage. The banks just take the signorage on all the credit they issue and stash it away as a kind of hidden benefit, so why not tax that and give some of the profit from printing money to the state?
Martin Wolf, in an interesting article cited by my right hon. Friend the Member for Oldham West and Royton (Mr Meacher), has argued that only central banks should create new money and that it should be regulated by a public credit authority, rather like the Monetary Policy Committee. I think that that would be a solution and a possible approach. Why should we not regulate the issue of credit in that fashion?
That brings us back to the old argument about monetarism: whether credit creation is exogenous or endogenous. The monetarists thought that it was exogenous, so all we have to do is cut the supply of money into the economy in order to bring inflation under control. That was a myth, of course, because we cannot actually control the supply of money; it is endogenous. The economy, like a plant, sucks in the money it needs. But that can be regulated by a public credit authority so that the supply matches the needs of the economy, rather than being excessive, as it has been over the past few years. I think that that kind of credit authority needs to be created to regulate the flow of credit.
That brings me to the Government’s economic policy. The Government tell us that they have a long-term economic plan, which of course is total nonsense. Their only long-term economic plan is slash and burn. The only long-term economic planning that has been done is by the Bank of England.
Mr MacNeil: To quote Harry S. Truman, the worst thing about economists is that they always say, “On the other hand”. The hon. Gentleman talks about limiting and regulating how much money is to be sucked in by the economy, but who would decide that? The difficulty is that although the economy might be overheating in a certain part of the country, such as the south-east of England, it could be very cool in others, such as the north of Scotland. What might be the geographical effects of limiting the money going into the economic bloodstream if some parts of the plant—I am extending his metaphor—need the nutrients while other parts are getting too much?
Austin Mitchell: The hon. Gentleman often asks tricky questions, but this one is perfectly clear-cut. The credit supply for the peripheral and old industrial parts of the economy, which include Scotland, but also Grimsby, has been totally inadequate, and the banks have been totally reluctant to invest there. I once argued for helicopter money, as Simon Jenkins has proposed, whereby we stimulate the economy by putting money into helicopters and dropping it all over the country so that people will spend it. I would agree to that, provided that the helicopters hover over Grimsby, but I would have them go to Scotland as well, because it certainly deserves its share, as does the north of England. However, I do not want to get involved in a geographical dispute over where credit should be created.
The only long-term plan has been that of the Bank of England, which has kept interest rates flat to the floor for six years or so—an economy in that situation is bound to grow—and has supplemented that with quantitative easing. We have created £375 billion of money through quantitative easing. It has been stashed away in the banks, unfortunately, so it has served no great useful purpose. If that supply of money can be created for the purpose of saving the banks and building up their reserve ratios, it can be used for more important purposes—the development of investment and expansion in the economy. This is literally about printing money. Those of us with a glimmering of social credit in our economics have been told for decades, “You can’t print money—it would be terrible. It would be disastrous for the economy to print money because it leads to inflation.” Well, we have printed £375 billion of money, and it has not produced inflation. Inflation is falling.
Steve Baker rose—
Austin Mitchell: I am sorry—I am mid-diatribe and do not want to be interrupted.
It has proved possible to print money. The Americans have done it—there has been well over $1 trillion of quantitative easing in the United States. The European Central Bank is now contemplating it, as Mr Draghi casts around for desperate solutions to the stagnation that has hit the eurozone. The Japanese, surprisingly, did it only last week. If all can do it, and if it has been successful here and has not led to inflation, we should be able to use it for more useful and productive economic purposes than shoring up the banks.
If we go on creating more money through quantitative easing, we should channel it through a national investment bank into productive investment such as contracts for house building and new town generation. Through massive infrastructure work—although I would not include HS2 in that—we can stimulate the economy, stimulate growth, and achieve useful purposes that we have not been able to achieve. This is a solution to a lot of the problems that have bedevilled the Labour party. How do we get investment without the private finance initiative and the heavy burden that that imposes on health services, schools, and all kinds of activities? Why not, through quantitative easing, create contracts for housing or other infrastructure work that have a pay-off point and produce assets for the state?
I mentioned the article in which Martin Wolf advocates the approach of the Monetary Policy Committee. That is how we should approach this. I welcome this debate because it has to be the beginning of a wider debate in which we open our minds to the possibilities of managing credit more effectively for the better building of the strength of the British economy.
Zac Goldsmith (Richmond Park) (Con): I want to put on record my gratitude to my hon. Friend the Member for Wycombe (Steve Baker) for having initiated this debate, and to his supporters from various parties. Having heard his speech—or most of it; I apologise for being late—I am even more satisfied that it was right to cast my vote for him to join the Treasury Committee.
My hon. Friend has introduced an incredibly important debate. As we have heard, this issue has not been debated here for well over a century. We would not be having it were it not for the fact that we are still in the midst of tumultuous times. We had the banking crash and the corresponding crash in confidence in the banking system and in the wider economy, and now, partly as a consequence, we have the problem of under-lending, particularly to small and medium-sized businesses. This subject could not be more important.
The right hon. Member for Oldham West and Royton (Mr Meacher)—I will call him my right hon. Friend because we work together on many issues—pointed out at the beginning of his speech that this issue is not well understood by members of the public. As I think he said later—if not, I will add it—it is also not well understood by Members of Parliament. I would include myself in that. I suspect that most people here would be humble enough to recognise that the banking wizardry we are discussing is such a complex issue that very few people properly understand it.
Bob Stewart: I totally associate myself with my hon. Friend’s comments about ignorance and include myself in that. It seems to me that the system is broken. The banks will not lend money because the Government have told them that they have to keep reserves. We do not like quantitative easing because that means that the banks are not lending. There is something very wrong with the system. It is not a case of “if the system isn’t broke, don’t fix it”, but “the system is broke, and someone’s got to fix it”.
Zac Goldsmith: My hon. Friend makes a valuable point that I will come to later.
If Members of Parliament do not really understand how money is created—I believe that that is the majority position, based on discussions that I have been having—how on earth can we be confident that the reforms that we have brought in over the past few years are going to work in preventing repeated collapses of the sort that we saw before the last election? In my view, we cannot be confident of that. The problem is the impulsive position taken by ignorant Members. I do not intend to be rude; as I said, I include myself in that bracket. For too many people, the impulse has been simply to call for more regulation, as though that is going to magic away these problems. As my hon. Friend the Member for Wycombe said, there are 8,000 pages of guidance in relation to one aspect of banking that he discussed. The problem is not a lack of regulation; it is the fact that the existing regulations miss the goal in so many respects. Banking has become so complex and convoluted that we need an entirely different approach.
When we talk to people outside Parliament about banking, the majority have a fairly simple view—the bank takes deposits and then lends, and that is the way it has always been. Of course, there is an element of truth in that, but it is so far removed from where we are today that it is only a very tiny element.
Steve Baker: My hon. Friend mentions the idea of straightforward, carry-through lending. When people talk about shadow banking, they are usually talking about asset managers who are lending and are passing funds straight through—similarly with peer-to-peer lenders. I am encouraged by the fact that when people are freely choosing to get involved with lending, they are not using the expansionary process but lending directly. Whereas the banks are seen simultaneously to fail savers and borrowers, things like peer-to-peer lending are simultaneously serving them both.
Zac Goldsmith: That is a really important point. There is a move towards such lending, but unfortunately it is only a fringe move that we see in the credit unions, for example. It is much closer to what original banking—pure banking or traditional banking—might have looked like. We even see it in some of the new start-ups such as Metro bank; I hesitate to call it a start-up because it is appearing on every high street. Those banks have much more conservative policies than the household-name banks that we have been discussing.
Most people understand the concept of fractional reserve banking even if they do not know the term—it is the idea that banks lend more than they can back up with the reserves they hold.
Guy Opperman (Hexham) (Con): My hon. Friend mentioned Metro, whose founder is setting up a bank—in which I should declare an interest—called Atom in the north-east. It is one of some 22 challenger banks of which Metro was the first. I missed the opening of the debate, so I have not heard everything that has been said, but I do not accept that it is all doom and gloom in banking. Does he agree that these new developments are proof that the banking system is changing and the old big banks are being replaced with the increased competition that we all need?
Zac Goldsmith: I certainly agree with the sentiment expressed. I am excited by the challengers, but I do not believe that it is enough. Competition has to be good because it minimises risk. I know that my hon. Friend the Economic Secretary has dwelt on and looked at this issue in great detail.
Even fractional reserve banking is only the start of the story. I will not repeat in detail what we have already heard, but banks themselves create money. They do so by making advances, and with every advance they make a deposit. That is very poorly understood by people outside and inside the House. It has conferred extraordinary power on the banks. Necessarily, naturally and understandably, banks will use and have used that power in their own interests. It has also created extraordinary risk and, unfortunately, because of the size and interconnectedness of the banks, the risk is on us. That is why I am so excited by the challengers that my hon. Friend has just described. As I have said, that is happening on the fringe: it is right on the edge. It is extraordinary to imagine that at the height of the collapse the banks held just £1.25 for every £100 they had lent out. We are in a very precarious situation.
When I was much younger, I listened to a discussion, most of which I did not understand, between my father and people who were asking for his advice. He was a man with a pretty good track record on anticipating turbulence in the world economy. He was asked when the next crash would happen, and he said, “The last person you should ask is an economist or a business man. You need to ask a psychiatrist, because so much of it involves confidence.” The point was proven just a few years ago.
The banking system and the wider economy have become extraordinarily unhinged or detached from reality. I would like to elaborate on the extraordinary situation in which it is possible to imagine economic growth even as the last of the world’s great ecosystems or the last of the great forests are coming down. The economy is no longer linked to the reality of the natural world from which all goods originally derive. That is probably a debate for another time, however, so I will not dwell on it.
Mr MacNeil: The hon. Gentleman is making a good point that we should remember. It was brought home to me by Icelandic publisher Bjorn Jonasson, who pointed out that we are not in a situation where volcanoes have blown up or there have been huge national disasters, famines or catastrophes brought on by war; as a couple of the hon. Gentleman’s colleagues have said, this is about a system failure within the rules, and it is worth keeping that in mind. Although there is much gloom in relation to the banking system, in many ways that should at the same time give us some hope.
Zac Goldsmith: The hon. Gentleman is right, but a growing number of commentators and voices are anticipating a much larger crash than anything we have seen in the past few years. I will not add to or detract from the credence of such statements, but it is possible to imagine how such a collapse might happen, certainly in the ecological system. We are talking about the banking system, but the two systems are not entirely separate.
We had a wake-up call before the election just a few years ago. My concern is that we have not actually woken up. It seems to me that we have not introduced any significant or meaningful reforms that go to the heart of the problems we are discussing. We have been tinkering on the edges. I do not believe that Parliament has been as closely involved in the process as it should be, partly because of the ignorance that I described at the beginning of my speech.
I want to put on the record my support for the establishment of a meaningful monetary commission or some equivalent in which we can examine the pros and cons of shifting from a fractional reserve banking system to something closer to a full reserve banking system, as some hon. Members have said. We need to understand the pros and cons of such a move, how possible it is, and who wins and who loses. I do not think that many people fully know the answers.
We need to look at quantitative easing. I think that hon. Members on both sides of the House have accepted that it is not objective. Some believe that it is good and others believe that it is bad, but no one believes that it is objective. If the majority view is that quantitative easing is necessary, we need to ask this question: why not inject those funds into the real economy—into housing and energy projects of the kind that Opposition Members have spoken about—rather than using the mechanism in a way that clearly benefits only very few people within the world of financial and banking wizardry that we are discussing?
The issues need to be explored. The time has come to establish a monetary commission and for Parliament to become much more engaged. This debate is a very small step in that direction, and I am very grateful to its sponsors. I wish more Members were in the Chamber—I had intended to listen, not to speak—but, unfortunately, there have not been many speakers. This is a beginning, however, and I hope that we will have many more such debates.
12.55 pmMark Durkan (Foyle) (SDLP): I rise to endorse the very significant points made by hon. Members. In particular, I pay tribute to the hon. Member for Wycombe (Steve Baker) for securing the debate and for opening it so strongly. From hearing him speak in Public Bill Committees on banking reform and related questions, I know that he is dubious about our having almost feng shui arguments on the regulatory furniture when there are fundamental questions to be asked about the very foundations of the system. He amplified that point in his speech.
My right hon. Friend the Member for Oldham West and Royton (Mr Meacher) made the point that the whole approach to quantitative easing—several Members have questioned it at a number of levels—proves that the underlying logic of sovereign money creation is feasible and workable. It is strange that some of the people who would dispute or refute the case for sovereign money creation sometimes defend quantitative easing in its existing form and with its current features.
In many ways, quantitative easing has shown that if we are to use the facility of the state—in this situation, the state’s main tool is the Bank of England—to alter or prime the money supply in a particular way, we could choose a much better way of doing so than through quantitative easing. It is meant to have increased the money supply, but where have people felt that in terms of business credit, wages or the stimulus that consumer power can provide?
When we look back at the financial crash and its aftermath, we can see evidence—not just in the UK, but in Ireland and elsewhere—showing that much of what we were told about the worth or the wealth of various sectors in the economy up until the crash has turned out to be vacuous, while the poverty lying in its trail has been vicious. The worth or the wealth was not real, but the poverty is real. People in organisations such as Positive Money in the UK or Sensible Money in Ireland are therefore saying, rightly, that politics—those of us charged with overseeing public policy as it affects thev economy—need to have more of a basic look at how we treat the banking system and at the very nature of money creation.
As someone who grew up in Northern Ireland, I am very used to the idea of having different banknotes—banks issuing their own money—but we do not think much about that, because we think that all that happens in the Bank of England or under its licence. As a member of the Financial Services Public Bill Committee and the Financial Services (Banking Reform) Public Bill Committee, it seems to me that although it has been recognised that some regulatory powers should go back to the Bank of England, the arrangements for regulation and the Bank of England’s role are still very cluttered.
In fact, in trying to correct the regulatory deficiencies that existed before the crash, there is a risk that we have perhaps created too many conflicting and confusing roles for the Bank of England. Given the various personages, different roles and job descriptions that attach to some of those committees, it seems to me that there is potential for clutter in the Treasury. The common denominator and reference point in the range of different committees and bodies and the things they do, is the Treasury. When the Treasury exercises its powers, influences judgments, and informs the criteria and considerations of those different committees under the Bank of England, there is not enough scrutiny or back play through Parliament.
I endorse the points made by other hon. Members about ensuring more accountability, whether through more formal reference to the Treasury Committee or some other hybrid, as suggested in an intervention on the right hon. Member for Oldham West and Royton. There should be more parliamentary insight—and definitely parliamentary oversight—on these matters. We cannot suddenly be shocked that all the confidence in various regulatory systems turned out to have been badly placed. That was our experience the last time, when people who now criticise the previous Government for not having had enough regulation were saying that there was too much regulation and calling for more deregulation.
If we in this Parliament have produced a new regulatory order, we must be prepared to face and follow through the questions that arise. It is not good enough to ensure that the issue returns to Parliament only the next time there is a crisis, when we will have to legislate again. We should do more to be on our watch. The hon. Member for Wycombe and other hon. Members who secured this debate have done us a service. We want more of a parliamentary watch window on these issues.
There is a necessary role for banks in the creation of money and quantitative easing, but we must entrust them with the right role and with the appropriate controls and disciplines. That is fundamental. It is not good or strong enough that we leave it to the whims of the banks and their lending—supposedly reinforced and stimulated by quantitative easing—to profile the performance of the economy.
If quantitative easing works on the basis of the Bank of England, through the asset purchase facility, essentially using money that it creates under quantitative easing to buy gilts from a pension fund whose bank account is with RBS—which in essence is owned by the Bank of England—then RBS’s bank account with the Bank of England goes up by the value of that gilt purchase. Simultaneously, the bank account of the pension fund goes up by that amount, and we are told that the UK money supply has increased. Yes, in theory the pension fund can purchase other assets—is that what is happening?—but while 1% of the big money holders and players appear to have been advantaged through quantitative easing, where is the trickledown to the rest of the economy? It is not there.
The sovereign money creation model seems to be primed much more specifically on a view of the total economy and providing a broad, stable and more balanced approach to stimulus and economic performance. We have had the slowest recovery coming out of a recession with quantitative easing. I do not say that to get some voice-activated reaction from the Government about how good the recovery and performance is, but in broader historical terms it is the slowest recovery, which also leaves questions about quantitative easing.
We heard from the Prime Minister about red warning lights on the dashboard of the world economy, and I wonder whether he would ever say that, to his mind, those warning lights include the degree to which global banks are now playing heavily in derivatives again, and there needs to be more action. That raises issues not just of regulation at national level, but at international level.
1.5 pmCatherine McKinnell (Newcastle upon Tyne North) (Lab): I congratulate the hon. Member for Wycombe (Steve Baker) on his thoughtful and thorough opening speech, as well as my right hon. Friend the Member for Oldham West and Royton (Mr Meacher) on his remarks. In their absence I also congratulate the hon. Members for Brighton, Pavilion (Caroline Lucas) and for Clacton (Douglas Carswell) on securing today’s important debate.
This debate follows a significant campaign by Positive Money, which has raised important issues about how we ensure financial stability, and how we as parliamentarians and members of the public can gain a greater understanding of the way our economy works, in particular how money is supplied not just in this country but around the world.
Some important questions have been highlighted in the debate, although not all have been answered. There are questions about how money is created, how money or credit is used by banks and others, how our financial system can be more transparent and accountable, and particularly how it can benefit the country as a whole. That latter point is something that Labour Members have been acutely focused on. How do we re-work our economy, whether in banking or in relation to jobs and wages, so that it works for the country as a whole?
It is worth reflecting on our current system and what it means for money creation. As the hon. Member for Wycombe set out eloquently in his opening speech, we know that currency is created in the conventional sense of being printed by the Bank of England, but commercial banks can create money through account holders depositing money in their accounts, or by issuing loans to borrowers. That obviously increases the amount of money available to borrowers and within the wider economy. As the Bank of England made clear in an article accompanying its first quarterly bulletin in 2014:
Commercial banks do not have unlimited ability to create money, and monetary policy, financial stability and regulation all influence the amount of money they can create. In that sense, banks are regulated by the Prudential Regulation Authority, part of the Bank of England, and the Financial Conduct Authority. Those regulators, some of which are—rightly—independent, are the stewards of “safety and soundness” in financial institutions, especially regarding banks’ money-creating practices.
Banks are compelled to manage the liabilities on their balance sheets to ensure that they have capital and longer-term liabilities precisely to mitigate risks and prevent them from effectively having a licence to print money. Banks must adhere to a leverage ratio—the limit on their balance sheets, compared with the actual equity or capital they hold—and we strongly support that. Limiting a bank’s balance sheet limits the amount of money it can create through lending or deposits. There are a series of checks and balances in place when it comes to creating money, some of which the Opposition strongly supported when we debated legislative changes in recent years. It remains our view that the central issue, the instability of money supply within the banking system, is less to do with the powers banks hold and how they create money than with how they conduct themselves and whether they act in the public interest in other ways too.
We believe the issues relate to the incentives in place for banks to ensure that loans and debts are repaid, and granted only when there is a strong likelihood of repayment. When the money supply increases rapidly with no certainty of repayment, that is when real risks emerge in the economy. Those issues were debated at great length when the Financial Services (Banking Reform) Act 2013 made its way through Parliament, following recommendations from Sir John Vickers’ Independent Commission on Banking and the Parliamentary Commission on Banking Standards, which considered professional standards and culture in the industry. The 2013 Act created the Prudential Regulation Authority and gives regulators the power to split up banks to safeguard their future, to name just two examples of changes that were made. However, we feel that it did not go far enough.
The Opposition’s concern is that the Government’s actions to date in this area have fallen short of the mark. They have failed to boost sufficient competition in the banking industry to raise those standards and to create public confidence in the sector. As hon. Members with an interest in this area know, we tabled a number of amendments to try to strengthen the Bill, and to prevent banks from overreaching themselves and taking greater risks, by ensuring that the leverage ratio is effective. That goes to the heart of many of the issues we are debating today. The Government rejected our proposals to impose on all those working in the banking industry a duty of care to customers. That would help to reform banking so that it works in the interests of customers and the economy, and not solely those of the banks. Those are the areas on which we still feel that reform is needed in the sector.
It is clear from this debate that there is a whole range of issues to consider, but our focus is that the banks need to be tightly and correctly regulated to ensure that they work for the whole economy, including individuals and small and large businesses. That is the key issue that we face at present. Only when the banks operate in that way and work in the interests of the whole economy will we find our way out of the cost of living crisis that so many people are facing.
I thank hon. Members for securing this very important debate and for the very interesting contributions that have been made from all sides of the House. I am pretty certain that this is not the end of the conversation. The debate will go on.
1.12 pmThe Economic Secretary to the Treasury (Andrea Leadsom): I too congratulate hon. Members on securing this fascinating debate. It is long overdue and has allowed us to consider not just what more we can do to improve what we have but whether we should be throwing it away and starting again. I genuinely welcome the debate and hope that many more will follow. In particular, I pay tribute to my hon. Friend the Member for Wycombe (Steve Baker), who now sits on the Treasury Committee on which I had the great honour to serve for four years. I am sure that his challenge to orthodoxy will have been extremely welcomed by the Committee and by many others. I wish him good luck on that.
Steve Baker: May I just say how much I am enjoying my hon. Friend’s place on the Committee? I congratulate her on her promotion once again.
Andrea Leadsom: I am grateful to my hon. Friend.
My right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley) gave a fantastic explanation that I would commend to anybody who wants to understand how money is created. He might consider delivering it under the financial education curriculum in schools. It was very enlightening, not least because it highlighted the appalling failure of regulation in the run-up to the financial crisis that is still reverberating in our economy today. All hon. Members made interesting points on what we can do better and whether we should be thinking again. I pay tribute to the right hon. Member for Oldham West and Royton (Mr Meacher) for his good explanation of the Positive Money agenda, which is certainly an idea worthy of thought and I will come on to it.
Money creation is an important and complex aspect of our economy that I agree is often misunderstood. I would therefore like quickly to set out how the system works. The money held by households and companies takes two forms: currency, which is banknotes and coins, and bank deposits. The vast majority, as my hon. Friend pointed out, is in the form of bank deposits. He is absolutely right to say that bank deposits are primarily created by commercial banks themselves each time they make a loan. Whenever a bank makes a loan, it credits the borrower’s bank account with a new deposit and that creates “new money”. However, there are limits to how much new money is created at any point in time. When a bank makes a loan, it does so in the expectation that the loan will be repaid in the future—households repay their mortgages out of their salaries; businesses repay their loans out of income from their investments.
In other words, banks will not create new money unless they think that new value will also in due course be created, enabling that loan to be paid back.
Ultimately, money creation depends on the policies of the Bank of England. Changes to the bank rate affect market interest rates and, in turn, the saving and borrowing decisions of households and businesses. Prudential regulation is used if excessive risk-taking or asset price bubbles are creating excessive lending. Those checks and balances are an integral part of the system.
I agree fully that the regulatory system was totally unfit in the run-up to the financial crisis. We saw risky behaviour, excessive lending and a general lack of restraint on all sides. The key problem was that the buck did not stop anywhere. When there were problems in the banking system, regulators looked at each other for who was responsible. We all know that the outcome was the financial crisis of 2008. I, too, see the financial crisis as a prime example of why we need not just change but a better banking culture: a culture where people do not spend their time thinking about how to get around the rules; a culture where there is no tension between what is good for the firm and what is good for the customer; and a culture where infringements of the rules are properly and seriously dealt with.
I will touch on what we are doing to change the regulations and the culture, but first I will set out why we do not believe that the right solution is the wholesale replacement of the current system by something else, such as a sovereign monetary system. Under a sovereign monetary system, it would be the state, not banks, that creates new money. The central bank, via a committee, would decide how much money is created and this money would mostly be transferred to the Government. Lending would come from the pool of customers’ investment account deposits held by commercial banks.
Such a system would raise a number of very important questions. How would that committee assess how much money should be created to meet the inflation target and support the economy? If the central bank had the power to finance the Government’s policies, what would the implications be for the credibility of the fiscal framework and the Government’s ability to borrow from the market if they needed to? What would be the impact on the availability of credit for businesses and households? Would not credit become pro-cyclical? Would we not incentivise financing households over businesses, because for businesses, banks would presumably expect the state to step in? Would we not be encouraging the emergence of an unregulated set of new shadow banks? Would not the introduction of a totally new system, untested across modern advanced economies, create unnecessary risk at a time when people need stability?
Steve Baker: I do not actually support Positive Money’s proposals, although I am glad to work with it because I support its diagnosis of the problem. Of course, this argument could have been advanced in 1844 and it was not. I have not proposed throwing away the system and doing something radically new; I have proposed getting rid of all the obstacles to the free market creating alternative currencies.
Andrea Leadsom: I am grateful to my hon. Friend for pointing that out. I must confess that before the debate I was puzzled that such an intelligent and extremely sensible person should be making the case for a sovereign monetary system, which I would consider to be an extraordinarily state-interventionist proposal. I am glad to hear that is not the case. In addition, of course, bearing in mind our current set of regulators, presumably we would then be looking at a committee of middle-aged, white men deciding what the economy needs, which would also be of significant concern to me.
Mr Meacher: Before the Minister leaves the question of a sovereign monetary system, which she obviously totally opposes and to which she raised several objections that I cannot answer in an intervention, does she not believe that the system of bank money creation is highly pro-cyclical and has enormously benefited property and financial sectors to the disadvantage of the vast range of industries outside the financial sector?
Andrea Leadsom: As I said, I sincerely congratulate the right hon. Gentleman on raising this matter; it is certainly worthy of discussion, and I look forward to him responding to some of my arguments. I agree that where we were in the run-up to the financial crisis was entirely inappropriate, and I will come to some of the steps we have taken to improve—not throw away the baby with the bathwater—what we have now, rather than throwing it away and starting again.
I know that some of my hon. Friends and Opposition Members have a particular concern about quantitative easing—I have made it clear that I do too—specifically about how we might unwind it. However, they must agree that at least it can be unwound, unlike the proposal for “helicopter money”, which would seem to be a giant step beyond QE—a step where money would be created by the state with no obvious way to rein it back if necessary.
If the tap in my bathroom breaks, rather than wrenching the sink off the wall, I would prefer to fix the tap. As Martin Wolf said last week, “nobody can say with confidence” how a monetary system should be structured and what laws and regulations it should have. Given that and the economic tumult across the world, we should be devoting our energies to fixing the system we have—mending the problems but keeping what works. For that reason, the Government have taken significant steps to improve the banking sector, making sure it fulfils its core purpose of keeping the wheels of the economy well oiled.
We are creating a better, safer financial system, with the Financial Policy Committee, created in this Parliament, focused on macro-prudential analysis and action. As the hon. Member for Newcastle upon Tyne North (Catherine McKinnell) pointed out, the FPC has been given counter-cyclical tools to require more capital to be held and to increase the leverage ratio and the counter-cyclical capital buffers when the economy is over-exuberant in order to push back against it—as the previous Governor of the Bank of England said, to remove the punch bowl while the party is still in full flow. That is incredibly important. We are also reducing dependence on debt. Since the financial crisis, the UK banking system has been forced significantly to strengthen its capital and liquidity position, and it is continuing to do so.
I must stress, however, that regulation alone will never be enough, which is why the Government are promoting choice, competition and diversity. I am delighted that 25 new banks are talking to the Prudential Regulatory Authority about getting a bank licence. We are also making strong efforts to promote the mutual sector; to enhance the capacity of credit unions to serve the real economy better; to enable booster funding for small businesses; to help families; and to improve customer service. We have put in place schemes to help the transmission of money from banks to customers, including the funding for lending scheme, which has lowered the price and increased the availability of credit for small and medium-sized businesses. As I think the hon. Member for Newcastle upon Tyne North said, we have also created the British business bank, which is helping finance markets work better for small firms, and are investing much resource and effort to build that up and help businesses in our economy.
We also have a programme of measures to increase competition in the SME lending market, including flagship proposals to open up access to SME credit information, which will help challengers to get in on the act, and to have banks pass on declined applications for finance to challenger banks. In addition, we now have an appeals process whereby small businesses turned down for funding can get a second chance, which has secured an additional £42 million of lending since its launch. These are all measures to help small businesses access finance. Then, to mitigate the problem of house price bubbles, we are putting in place supply-side reforms to promote home building and home owning, as well as measures enabling the PRA to limit the amount of lending that households can take on.
I agree with Members on both sides of the House, however, that we should not be content with the system as it stands. We must seek to improve it and make it function better. In Mark Carney, we have an excellent central banker who has the experience and knowledge to put the right reforms in place and see them through. As he says:
“Reform should stop only when industry and society are content, and finance justifiably proud.”
In the medium to long term, we need to create a culture where research and analysis do not shy away from going against the orthodoxy. As hon. Members across the House have said, we need to consider alternatives, and we should be having that discussion; it is healthy to do so, because that is how to make progress. For that reason, the call from Andy Haldane, the Deputy Governor of the Bank of England, for a broader look at new and existing monetary ideas is exactly right.
Mr Meacher: I am pleased the Minister thinks that alternative ways of improving the monetary system should be explored. Will she support the idea of a setting up a commission to examine the alternatives, as recommended by the hon. Member for Richmond Park (Zac Goldsmith), as well as by me—so there is some cross-part support on this? Is that not an idea whose time has come?
Andrea Leadsom: I think that an organisation such as the Treasury Committee, of which my hon. Friend the Member for Wycombe is member, would be entirely the right place to have such a discussion, and of course we also had the Vickers commission, which looked at what went wrong and what measures could be put in place, and the Parliamentary Commission on Banking Standards, which specifically addressed the issue of incentives and motivations in banking. I would not normally advocate the establishment of great new commissions; we already have the bodies to look further at different orthodoxies, and as Andy Haldane has said, the Bank itself will be looking at, and encouraging, the exploration of alternative views.
Of course, we also need to continue embracing innovation, both in the “software” of how payments are made and in the “hardware” of new currencies, such as crypto-currencies and digital currencies—both could open up competition and give customers greater choice and access to funding—but we must do so with caution. In November, we published a call for information inviting views and evidence on the benefits and risks of digital currencies so that digital currency businesses can continue to set up in the UK and people can expect to use them safely.
I am the last person who could be described as statist, but I accept that we must always be ruthless in our determination to regulate new ideas that come to the fore, because as sure as night follows day, as new ideas come in, through shadow banking, new lending ideas and so on, some people will seek to manipulate new schemes and currencies for fraudulent purposes. I am absolutely alive to that fact. It is important, therefore, that the Government carry out the necessary research.
The Government believe that the current system, modified and improved with far greater competition, can service the economy best. However, reform is vital. Again as Andy Haldane puts it:
1.29 pmSteve Baker: This debate has been a joy at times, and I am extremely grateful to right hon. and hon. Members who helped me to secure it. The right hon. Member for Oldham West and Royton (Mr Meacher) made clear his support for sovereign money. One of the great advantages of such a system is that it would make explicit what is currently hidden—that it is the state that is trying to steer the monetary system—and if such a system failed, it would at least be clear that it was a centrally planned monetary order that had failed.
The hon. Member for Clacton (Douglas Carswell) talked about the ownership of deposits, and I was glad to support his private Member’s Bill. I am reminded of the intervention from the hon. Member for Hackney North and Stoke Newington (Ms Abbott), who talked about deposit insurance. One of the problems, as seen in Cyprus in the context of depositor “bail-ins”, is that deposits are akin to a share in a risky investment vehicle, so a little more clarity about what a deposit means and what risks depositors take could go a long way.
My right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley) highlighted one of the greatest controversies among free marketeers—whether or not fractional reserve deposit taking is legitimate.
The hon. Member for Great Grimsby (Austin Mitchell) mentioned Major Douglas, which he will have seen put a smile on my face. Major Douglas was dismissed as a crank, even by Keynes who dismissed him in his writing as a “private”. This highlights the fact that the possible range of debate is enormous.
I would like to leave my final words with Richard Cobden, the Member representing Stockport back in the time when this was also a big issue. He said:
Question put and agreed to.